[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]




   THE CURRENT STATE OF COMPETITION IN THE COMMUNICATIONS MARKETPLACE

=======================================================================

                                HEARING

                               before the

          SUBCOMMITTEE ON TELECOMMUNICATIONS AND THE INTERNET

                                 of the

                    COMMITTEE ON ENERGY AND COMMERCE
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                            FEBRUARY 4, 2004

                               __________

                           Serial No. 108-63

                               __________

       Printed for the use of the Committee on Energy and Commerce


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                 house


                               __________

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                    COMMITTEE ON ENERGY AND COMMERCE

               W.J. ``BILLY'' TAUZIN, Louisiana, Chairman

RALPH M. HALL, Texas                 JOHN D. DINGELL, Michigan
MICHAEL BILIRAKIS, Florida             Ranking Member
JOE BARTON, Texas                    HENRY A. WAXMAN, California
FRED UPTON, Michigan                 EDWARD J. MARKEY, Massachusetts
CLIFF STEARNS, Florida               RICK BOUCHER, Virginia
PAUL E. GILLMOR, Ohio                EDOLPHUS TOWNS, New York
JAMES C. GREENWOOD, Pennsylvania     FRANK PALLONE, Jr., New Jersey
CHRISTOPHER COX, California          SHERROD BROWN, Ohio
NATHAN DEAL, Georgia                 BART GORDON, Tennessee
RICHARD BURR, North Carolina         PETER DEUTSCH, Florida
  Vice Chairman                      BOBBY L. RUSH, Illinois
ED WHITFIELD, Kentucky               ANNA G. ESHOO, California
CHARLIE NORWOOD, Georgia             BART STUPAK, Michigan
BARBARA CUBIN, Wyoming               ELIOT L. ENGEL, New York
JOHN SHIMKUS, Illinois               ALBERT R. WYNN, Maryland
HEATHER WILSON, New Mexico           GENE GREEN, Texas
JOHN B. SHADEGG, Arizona             KAREN McCARTHY, Missouri
CHARLES W. ``CHIP'' PICKERING,       TED STRICKLAND, Ohio
Mississippi                          DIANA DeGETTE, Colorado
VITO FOSSELLA, New York              LOIS CAPPS, California
STEVE BUYER, Indiana                 MICHAEL F. DOYLE, Pennsylvania
GEORGE RADANOVICH, California        CHRISTOPHER JOHN, Louisiana
CHARLES F. BASS, New Hampshire       TOM ALLEN, Maine
JOSEPH R. PITTS, Pennsylvania        JIM DAVIS, Florida
MARY BONO, California                JAN SCHAKOWSKY, Illinois
GREG WALDEN, Oregon                  HILDA L. SOLIS, California
LEE TERRY, Nebraska                  CHARLES A. GONZALEZ, Texas
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
DARRELL E. ISSA, California
C.L. ``BUTCH'' OTTER, Idaho
JOHN SULLIVAN, Oklahoma

                   Dan R. Brouillette, Staff Director

                   James D. Barnette, General Counsel

      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

          Subcommittee on Telecommunications and the Internet

                     FRED UPTON, Michigan, Chairman

MICHAEL BILIRAKIS, Florida           EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas                      Ranking Member
CLIFF STEARNS, Florida               BOBBY L. RUSH, Illinois
  Vice Chairman                      KAREN McCARTHY, Missouri
PAUL E. GILLMOR, Ohio                MICHAEL F. DOYLE, Pennsylvania
CHRISTOPHER COX, California          JIM DAVIS, Florida
NATHAN DEAL, Georgia                 RICK BOUCHER, Virginia
ED WHITFIELD, Kentucky               EDOLPHUS TOWNS, New York
BARBARA CUBIN, Wyoming               BART GORDON, Tennessee
JOHN SHIMKUS, Illinois               PETER DEUTSCH, Florida
HEATHER WILSON, New Mexico           ANNA G. ESHOO, California
CHARLES W. ``CHIP'' PICKERING,       BART STUPAK, Michigan
Mississippi                          ELIOT L. ENGEL, New York
VITO FOSSELLA, New York              ALBERT R. WYNN, Maryland
CHARLES F. BASS, New Hampshire       GENE GREEN, Texas
MARY BONO, California                JOHN D. DINGELL, Michigan,
GREG WALDEN, Oregon                    (Ex Officio)
LEE TERRY, Nebraska
W.J. ``BILLY'' TAUZIN, Louisiana
  (Ex Officio)

                                  (ii)




                            C O N T E N T S

                               __________
                                                                   Page

Testimony of:
    Balhoff, Michael J., Managing Director, Telecommunications 
      Group, Legg Mason Inc......................................    11
    Louthan, Frank, Vice President, Equity Research, Raymond 
      James Financial, Inc.......................................    20
    Quinton, Adam, Managing Director & First Vice President, Co-
      Head of Global Telecom Services Research, Merrill Lynch & 
      Co., Inc...................................................    24
    Zachar, Ned P., CFA, founding Partner, Weisel Partners, 
      Director of Telecom Services Research, Lever House.........    29

                                 (iii)

  

 
   THE CURRENT STATE OF COMPETITION IN THE COMMUNICATIONS MARKETPLACE

                              ----------                              


                      WEDNESDAY, FEBRUARY 4, 2004

              House of Representatives,    
              Committee on Energy and Commerce,    
                     Subcommittee on Telecommunications    
                                          and the Internet,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 1:15 p.m., in 
room 2322, Rayburn House Office Building, Hon. Fred Upton 
(chairman) presiding.
    Members present: Representatives Upton, Barton, Stearns, 
Whitfield, Shimkus, Pickering, Terry, Markey, McCarthy, Davis, 
Towns, Stupak, Engel, and Dingell (ex officio).
    Staff present: Howard Waltzman, majority counsel; Neil 
Fried, majority counsel; Will Nordwind, majority counsel; 
William Carty, legislative clerk; Gregg Rothschild, minority 
counsel; Peter Filon, minority counsel; and Jessica McNiece, 
minority research assistant.
    Mr. Upton. Good afternoon. Today is the first in a series 
of hearings this year in which the subcommittee will examine 
the state of competition in the communications marketplace. 
What I think we will hear today from our witnesses is that the 
marketplace has evolved dramatically since Congressional debate 
on and passage of the Telecommunications Act of 1996.
    Without a doubt, intermodal facilities based competition 
has taken root, as both voice and data are being delivered into 
homes and businesses over multiple technological platforms. 
Wireless carriers are competing head to head with wire line 
carriers.
    Cable companies dominate the broadband marketplace in 
competition with telephone companies. Moreover, cable companies 
and others are rapidly ramping up their VoIP, ``voice over 
internet protocol'' offerings, which is transforming the whole 
voice marketplace. However, all of this robust competition is a 
by-product of the free market forces that have been allowed to 
flourish, where government, by and large, has kept its hands 
off.
    In stark contrast, certain elements of so called 
competition are government managed, based on an outdated notion 
of the telecommunications marketplace. I suspect we knew no 
better in 1996, but we know better now, and now is the time for 
Congress to begin the process of retooling the 1996 Act, to 
bring it up to speed to today's as well as tomorrow's 
marketplace and technology. That is what this hearing begins to 
do.
    I yield now to the ranking member, my friend, the very 
happy gentleman from Massachusetts, Mr. Markey, especially by 
Mr. Brady.
    Mr. Markey. We thank you for Tom Brady from Michigan and 
Boston. We thank you for the Michigan primary, for Mr. Kerry 
from Boston.
    Mr. Upton. Ty Law?
    Mr. Markey. Yes. Could I just pass at this moment? Would 
that be all right, and recognize one of the other members, and 
I will come back.
    Mr. Upton. Sure. Mr. Stearns.
    Mr. Stearns. Thank you, Mr. Chairman. I think we all 
remember the Telecom Act in 1996 and the significant changes it 
made, and I want to compliment you for having a hearing this 
morning to see the progress.
    In Florida, of course, we have seen CLECs obtain a roughly 
16 percent of the market share with the majority of that being 
in the business sector. Also, with the end of section 272 
applications, we have an indicator that the local market is 
sufficiently open to competition.
    In wireless, we see that nearly half the U.S. population 
subscribes to a wireless service provider. In short, the 
American consumer has not been disappointed with the 
availability of advanced and reliable telecommunications 
services and the ability to choose their provider through 
robust competition.
    Last year, of course, we had hearings on the health of the 
telecommunications sector. What we learned then, that 
regulatory uncertainty is a chief obstacle to sufficient and 
long term investment. I think that will probably be confirmed 
by a lot of our witnesses today.
    As we look at the regulatory arena, one particular area I 
would like to focus on is the voice over internet protocol. In 
2003 the State of Florida chose to allow voice over IP to 
develop free from unnecessary regulation, which is the proper 
course, in my opinion.
    Voice over has the capability to truly modernize the 
telecommunications market with advanced voice and data 
services. The FCC is currently examining this issue, and I 
think Chairman Powell is heading in the right direction in 
terms of voice over regulatory treatment. I do not envy their 
task, for there are a myriad of questions surrounding the 
developing of this technology.
    At its most basic, voice over converts analog signal to 
digital, transmits over an IP network, then reconverts to 
analog at the end user, phone to phone IP telephony. However, 
voice over can also operate solely on a broadband network.
    In this manner, the service does not access the public 
switch telephone network. You can also have a voice over phone 
transmitting to an analog phone whereby the PSTN is accessed at 
the receiving end.
    So herein lies the problem in pigeonholing voice over into 
an outdated regulatory framework. One voice over is not like 
the other. How do you address access charges when the PSTN is 
not accessed? Is voice over using only a broadband network, 
entirely a telecommunications service, enhanced service or 
simply an application?
    In addition, there are a number of consumer issues at hand. 
E-911: I do not believe that public safety should have to pick 
and choose which technology should adhere to E-911. This 
service should be uniform in the market, but on a pure voice 
over system, how do you locate the caller? If the user lives in 
Florida half the year, yet maintains a New York number, which 
PSAP is accessed?
    Among other issues, how would universal service obligations 
apply? What about services for the hearing impaired, number 
portability, and possible area code exhaustion?
    Here we are nearly 10 years after the Telecom Act of 1996, 
and we encounter a whole new technology that does not fit the 
regulatory framework that the Federal Government designed. So I 
think it is very appropriate, Mr. Chairman, that we see the 
health of the industry, talk about some of the new technology, 
and government, I think, should, if possible, not issue new 
regulation and just let the new technologies move forward and 
not be sentenced to a morass of outdated, inflexible 
regulations.
    So, Mr. Chairman, I again compliment you for this hearing, 
and I look forward to the testimony of our witnesses.
    Mr. Upton. Thank you. Mr. Markey.
    Mr. Markey. Thank you, Mr. Chairman, very much, and I 
wanted to compliment you this timely hearing.
    The telecommunications marketplace remains in the doldrums, 
although there are hopeful signs that parts of the marketplace 
are beginning to rebound. The health of the marketplace sector 
can be measured by various ways, and one's assessment of 
marketplace wellbeing depends on what one considers optimal 
health.
    The workforce looks to job growth and reasonable wage 
increases over time. Consumers typically look to choice, 
service quality, and price. Investors often look to the bottom 
line. That is profitability. Manufacturers like to have many 
outlets for their products, so that they have a myriad of 
potential buyers.
    As such, what investors may think constitutes a wise 
investment in a healthy economy or sector might put them at 
odds with what consumers and workers see as healthy. A 
telecommunications marketplace with multitudes of companies 
engaging in fierce competition with ever lower prices, higher 
quality and new services is the kind of market we seek to 
create and the kind of marketplace for which the vast majority 
of consumers yearn.
    Yet for investors, that kind of competition may not be a 
good investment, because it is a highly competitive 
marketplace, often with low profitability and higher risks. In 
other words, if you have one company with no competitors, that 
is the pluperfect risk free investment. A duopoly is slightly 
more risky but not much. Those are the kinds of companies 
Warren Buffet invests in.
    Yet such marketplace would be terrible for America, because 
it is anti-consumer, anti-innovation, and doesn't foster new 
jobs over the long run. Moreover, companies that successfully 
lower costs for operational support, customer support, 
telemarketing or billing services by shifting such operations 
to entities offshore in places like India, the Philippines or 
elsewhere might get kudos from investors for increasing 
profitability but receiving standing boos from high tech 
workers.
    According to Forester Research, over the next 15 years 3.3 
million U.S. service jobs and $136 billion in wages will move 
offshore, and the information technology sector will lead the 
initial overseas exodus. When such firms post lower costs and 
trumpet their profits to Wall Street, does that really 
constitute a healthy marketplace? Can we really herald an 
economic recovery if it comes without new jobs?
    A jobless recovery, Mr. Chairman, is like jumbo shrimp or 
Chevy Chase nightlife. There is no such thing, you know.
    so the challenge for telecommunications policymakers for 
many years has been to reform telecommunications statutes and 
rules in a way that substitutes a sound competitive policy 
framework consistent with the public interest for hitherto 
monopoly provided services.
    I believe a competition based policy is preferable, because 
it maximizes consumer choice, job creation, technological 
innovation, service quality, and price reductions.
    In addition, I contend that the economic interests of the 
United States are most advanced in the global marketplace by 
fully establishing competition in our domestic 
telecommunications markets.
    We still have progress to make on this front, but I remain 
hopeful that sooner, rather than later, the Federal 
Communications Commission will surely see that, without fleet-
footed, up and coming competitors with a legal right to access 
their customers in the marketplace, we will have no marketplace 
insurance that the large corporate owners of the wires will not 
grow complacent, that they are not again permitted to sit on 
innovation, keeping it on the shelves, and that they are forced 
by competitive paranoia to invest and upgrade.
    This is an important lesson for those who don't have a long 
history in dealing with monopolies from a policy standpoint to 
appreciate. That is because, when our telecommunications laws 
were written, our incumbent telecommunications companies were 
not exactly mobile. They were in a 100-year-old monopoly 
induced technological stasis.
    When our telecommunications laws were updated, however, the 
incumbents were forced to become mobile, to move to deploy new 
equipment, to move into new markets, and to move into new 
technology.
    Policy makers were successful in the sense that, when our 
new telecommunications laws were made, these companies were 
forced to become mobile, and we saw broadband go from zero 
customers in 1996 to over 80 percent of all Americans having 
access to it, past their front door today. That is an 
incredible public policy success story.
    We must ensure that we don't see any further backsliding 
from our policy preference for the types of vigorous 
competition that will keep the companies and market sectors 
moving. Mr. Chairman, I thank you for holding this hearing, and 
I look forward to hearing the witnesses.
    Mr. Upton. Thank you. Mr. Shimkus.
    Mr. Shimkus. Thank you, Mr. Chairman. Obviously, when the 
Telecom Act was written, we were still in what was known as the 
analog world, and now we have moved into the digital world.
    As the co-chairman of the House E-911 caucus, along with 
our colleague, Anna Eshoo, on the other side with Senator 
Clinton and Senator Burns, we have been addressing enhanced 911 
issues across the country. Voice over internet protocol is the 
new concern, for good and for bad.
    I think that we have the--Chairman Powell has recognized 
this in his statements, and there are many, many beneficial 
aspects that voice IP can bring to the enhanced 911 world. 
Since voice over internet is digital computing application, it 
can do more than just identify the location of the caller. It 
could also help notify an ambulance. It could notify a doctor, 
firefighters or even send an alert message to a family member.
    Chairman Powell has done an excellent job in forging 
cooperation between voice over internet providers and the 
National Emergency Number Association, known as NENA. He has 
also made E-911 a top priority at the Solution Summit on Voice 
over Internet, which are scheduled for the first and second 
quarter of this year.
    So I am excited about the opportunities, and this is 
actually a hearing to listen to our witnesses, and I hope to 
learn from them as we continue to move this debate forward. I 
yield back my time, Mr. Chairman.
    Mr. Upton. Thank you. Mr. Dingell.
    Mr. Dingell. Mr. Chairman, thank you for putting together 
this very important hearing.
    As I reviewed the testimony of the witnesses before us, 
three thoughts immediately came to mind. First, the 
communications marketplace has undergone truly amazing changes 
during the past several years. Second, the vast array of new 
products and services has tremendously benefited America's 
consumers, as has the continuing fall in prices for many basic 
telecommunication services. Finally, and this is particularly 
relevant to the work of this committee, there is virtually no 
correlation between the regulations that presently govern the 
communications marketplace and the networks and services that 
comprise this market today.
    Despite all the advances in technology and, in particular, 
the digitization of modern communications networks, the 
industry is still governed by laws that were passed before the 
emergence of the internet, some even before the introduction of 
color television.
    Of the two major titles of the Communications Act that 
govern the communications marketplace, the first was written 
many years ago to regulate the offering of switched analog 
deploy service over copper wiring. The second was written 
nearly as many years ago to regulate the offering of an analog 
one-way video service over coaxial cable.
    As we now all know too well, however, the analog world 
contemplated by the Communications Act no longer exists. 
Instead, the marketplace now features a truly impressive array 
of services offered over networks that were barely on the 
drawing board when we passed the 1996 Act: fiber to the home, 
WiFi, EVDO, just to name a few.
    What is even more amazing, in many cases today's digital 
networks are still governed by the old law. In contrast with 
the old networks that were all designed specifically to offer 
one particular service, such as analog voice, today's digital 
networks have no such limitations. Voice, video or data, it 
simply doesn't matter. In the new digital world, bits are bits, 
and the only limits on a network's ability are bandwidth and 
software.
    Mr. Chairman, despite what seems obvious, many in Congress 
do not seem to grasp these simple facts.
    Rather than grasp the exciting possibilities of new 
technologies, we choose to perpetuate the dying business models 
of certain politically entrenched companies. Rather than reward 
capital investment in new networks, we reward those companies, 
who shall go nameless, who feast like parasites off the hard 
work and the investment of others.
    I remain hopeful that the Congress will soon change course 
and fundamentally overhaul the law to reflect the advances in 
modern communications marketplaces. I am encouraged by the 
recent comments from Senator Stevens that he will examine the 
Communications Act during the next Congress, and I intend to 
push this committee to undertake a similar endeavor.
    Such changes are essential if we are to inspire new 
investments in our networks, create jobs, and rightfully reward 
these companies who are willing to risk their own capital.
    In the interim, Mr. Chairman, I recognize the FCC may soon 
commence a proceeding on the regulation of one of the new 
services we have rolled out in the marketplace, voice over 
internet protocol or VoIP telephone service. As the FCC moves 
forward on this proceeding, there are a number of economic and 
social implications that must be considered, most important of 
which are universal service, law enforcement, and 911 services.
    Based on recent news reports, I am concerned that the 
chairman of the FCC is not sufficiently aware of these issues. 
I caution the FCC to step back from its apparent rush to 
reclassify this service as a so called Title I Information 
Service. It may be far wiser for the FCC to regulate this 
service under Title II, which was written to apply to voice 
service, and then to forbear where appropriate.
    I look forward to hearing from today's witnesses, Mr. 
Chairman, and to the continuing debate over the many 
telecommunications issues before us. These are questions that 
we must address. Thank you.
    Mr. Upton. Thank you very much. Mr. Whitfield.
    Mr. Whitfield. Thank you, Mr. Chairman. I will waive.
    Mr. Upton. Mr. Towns.
    Mr. Towns. Thank you, Mr. Chairman. Let me begin by 
thanking you for holding this hearing.
    The landscape of the telecommunication industry is 
constantly changing. This makes it very challenging as 
legislators to create a regulatory environment that protects 
consumers, encourages investment, and fosters competition and 
innovation.
    What may seem like sound regulatory policy at the time it 
is created can soon become outdated as new technologies are 
developed, that no one thought of at the time. So we must 
continue to monitor the market to ensure that regulations are 
appropriate or if changes are needed.
    I look forward to hearing the witnesses to get a better 
sense of where the market is and where the market is headed, so 
we can do our best to promote regulatory structure to help 
consumers and ensure fair competition.
    One thing we do know, there is competition and choice for 
most consumers in the telecommunications industry. Most 
Americans have multiple telecommunication providers to choose 
from, and there is continued growing competition among 
telecommunication technologies.
    A good example for this is that the number of wireless 
phone lines now outnumber the number wired consumer phone 
lines. However, as new technologies become available and new 
choices emerge, we still have to be careful to protect those 
consumers who may not be able to take advantage of these 
choices.
    Right now, we are starting to see the growth of voice over 
internet protocol. It is estimated that one company using this 
technology has about 92,000 customers and is adding 1,000 
consumers a month. As everyone here knows, it is projected that 
many other companies will be offering this service real soon. 
However, because this service requires the use of broadband, 
not all consumers will be moving to this option, even down the 
road.
    In my district where many constituents still don't have a 
dial-up internet connection, let alone broadband access, voice 
over internet protocol, it is not an option for the foreseeable 
future. So I am concerned about what happens to regular local 
phone service for these consumers if the high paying, 
profitable customers migrate to voice over internet protocol.
    I am pleased that some companies considering voice over 
internet protocol recognize that we must balance the need to 
promote the technology with the need to protect certain 
consumers. The question is, where is that balance? I am hopeful 
today's witnesses might help bring some clarity to this issue.
    Mr. Chairman, on that note I yield back, and thank you 
again for holding this hearing. I think it is very timely.
    Mr. Upton. Thank you. Mr. Davis.
    Mr. Davis. I will reserve my time.
    Mr. Upton. Thank you. Ms. McCarthy.
    Ms. McCarthy. I will also reserve my time, Mr. Chairman.
    Mr. Upton. Thank you very much. Mr. Whitfield, you don't 
care to move forward either, right, with an opening statement? 
Reserve time. Note that those members who reserve their time 
get an extra 3 minutes for their questions. Thank you very 
much.
    [Additional statements submitted for the record follow:]

    Prepared Statement of Hon. Paul E. Gillmor, a Representative in 
                    Congress from the State of Ohio

    Thank you Mr. Chairman for this opportunity, not only to gauge the 
state of competition in the communications sector, but to lay the 
groundwork for addressing the insurgence of new technologies under 
current telecommunications law.
    With the enactment of the Telecommunications Act of 1996, we were 
certainly not as dependent on email or our cell phones when conducting 
business, and of course there wasn't a blackberry in sight. With the 
recent explosion in email, wireless, broadband, and soon, voice over 
Internet Protocol (VOIP) services, yesterday's advanced services such 
as Internet dial-up and land-lines are losing steam.
    I should also point out, that while telecommunications industry 
investment remains weak, consumers have an array of new services to 
choose from, reaching farther out to serve rural areas like my Ohio 
district. As we delve further into this important issue, we must again, 
provide a communications environment conducive to new investment, 
manufacturing, competition, and lower prices for our constituents.
    I welcome the well-balanced panel of research analysts and look 
forward to your testimony. Again, I thank the Chairman and yield back 
the remainder of my time.

                                 ______
                                 
Prepared Statement of Hon. Barbara Cubin, a Representative in Congress 
                       from the State of Wyoming

    Thank you, Mr. Chairman.
    I would like to welcome our distinguished panel B thank you all for 
joining us today and I look forward to hearing your testimony. I would 
also like to thank the distinguished Chairman for calling this hearing, 
because part of my obligation as a Member of Congress is reviewing the 
laws and making certain they are still serving their purpose. And I can 
tell you that just by looking around and seeing the number of mobile 
electronic devices in this hearing room, that we have come a long way 
from where we were when the 1996 Telecommunications Act was written. In 
fact, it's been a little like Moore's Law. In 1965, Gordon Moore, co-
founder of Intel, predicted that the number of transistors on a 
microprocessor would double approximately every 18 months. Well, that 
was in 1965 and he's pretty much hit the bull's eye.
    In the 1996 Act, Congress established a framework to radically 
reform telecommunications and create facilities-based telephone 
competition B one that opened up an incumbent's telco network to 
competitors. This led to a dizzying array of changes for companies, and 
choices for consumers. Now, in 2004, a quick look at the landscape 
would show explosive growth in the number of broadband connections, 
wireless users, and other innovative products and services. Companies 
are now using phone lines and cable connections for services that were 
scarcely imagined a decade ago, but like Moore's law, seemed to have 
doubled every 18 months.
    I'm sure everyone remembers back to 1994, before the advent of 
Windows 95 B using a 28.8 modem to dial-up to a painfully slow 
Internet, where few could afford the cost to install a T-1 connection 
to have faster service, and that www used to stand for ``world wide 
WAIT'' Now with the deployment of broadband, we can not only surf the 
Internet faster, but we are also on the verge of a new and exciting 
form of competition B intermodal.
    Instead of choosing between rival phone companies for service, or 
cable and satellite, or wireless, a consumer may soon select the type 
of connection she wants that will provide voice, data and video 
programming B all in one. This is competition in the truest sense of 
the word and a fascinating development. Instead of the heavy regulatory 
of burden of network sharing mandates and allegations from both sides 
about the fairness of the regulated UNE-P rate, there is now true 
incentive for companies who innovate and invest capital into their 
systems B without being forced to subsidize the competition. I guess 
that's why Voice over Internet Protocol (VOIP) is such a hot issue this 
year.
    As always, however, I am concerned that these innovations could 
again leave rural America in the digital dust. That's why I will be 
monitoring these developments closely to ensure that folks smart enough 
to live in Wyoming today will not be forced to use 20th Century 
technology.
    Thank you Mr. Chairman, I yield back the balance of my time.

                                 ______
                                 
Prepared Statement of Hon. Mary Bono, a Representative in Congress from 
                        the State of California

    Thank you for holding this timely hearing. The telecommunications 
industry has changed significantly since the passage of the 1996 Act, 
and Congress needs to reexamine the Act and decide how it should be 
applied to new technologies.
    When the 1996 Act was passed, broadband was not a part of the 
debate. While there was some talk of advanced services, and the 
Internet was mentioned, it was clearly not the focus of the Act. The 
main goal of the 1996 Act was to bring competition into the local and 
long distance telephone markets. On that point, the Act has been 
successful.
    Another goal of the Act--deregulation--has not happened for much of 
the telecommunications industry. So, what happens now? With technology 
such as VoIP, is it time to step back from regulation? What about 
wireless substitution? Wireless services are available and affordable 
throughout the country. Does that mean that the local exchange should 
be deregulated?
    What about broadband? Broadband is an example where regulation has 
been turned on its head. The cable industry controls about two-thirds 
of the U.S. broadband market, and is unregulated. Telephone-company 
broadband, known as DSL, has about a one-third market share and is 
heavily regulated. This makes little sense.
    I want to hear what our financial experts have to say about the 
effect of regulation on investment in telecommunications, job creation, 
and the economy in general. What will happen if the FCC finally 
deregulates broadband? What will happen if the local exchange is 
deregulated? What will this mean to the economy and investment?
    Thank you, Mr. Chairman, and I yield back the remainder of my time.

                                 ______
                                 
 Prepared Statement of Hon. W.J. ``Billy'' Tauzin, Chairman, Committee 
                         on Energy and Commerce

    Mr. Chairman, thank you for calling this hearing today. It is 
critical for this subcommittee to begin to examine the state of 
competition in the communications industry. Competition is thriving, 
but the manner in which competition is occurring is a lot different 
from the manner in which the Telecommunications Act of 1996 assumed 
competition would occur.
    I am delighted that we are finally beginning to witness true 
facilities-based competition. This competition has taken the form of 
inter-modal competition from different technological platforms.
    Wireless carriers are on a course to exceed the number of 
subscribers that wireline companies possess. And wireless is competing 
with wireline services on several fronts. First, for several years, 
wireless plans have included free long-distance calling, which has 
taken minutes away from traditional long-distance carriers. Second, an 
increasing number of wireless subscribers are ``cutting the cord,'' 
abandoning their wireline service completely. This trend is being 
accelerated by wireline-to-wireless local number portability rules. 
Third, wireless companies are beginning to deploy wireless broadband 
services that compete directly with DSL and high-speed cable-modem 
services.
    Cable companies also provide vigorous competition in the 
communications marketplace. Cable companies dominate the broadband 
market by a margin of almost two-to-one. Cable companies have more than 
3 million telephone customers, and the advent of Voice-over-Internet-
Protocol (VOIP) services will keep that number rising.
    And VOIP services will become an important source of competition 
from companies other than cable companies. Vonage just reached the 
100,000-customer mark. Thirteen months ago, Vonage had only 7,500 
customers. And the continued increase in broadband subscribership will 
just increase the number of households that can access Vonage-type 
services.
    Competition therefore is thriving. But the type of competition we 
are witnessing calls many of the assumptions underlying the 
Telecommunications Act into question. If competition can emanate so 
readily from these different inter-modal sources, why does any company 
need to be subject to common carrier-type regulations? The wireless 
industry and cable companies, in terms of their deployment of broadband 
services, are great examples of what happens when Congress and 
regulators permit new services to flourish without subjecting them to 
onerous regulations. Congress needs to think about revisiting the 1996 
Act and applying the lessons we learned with wireless and cable-
broadband to the entire communications sector. In the face of 
competition from multiple platforms, what other direction could we 
possibly take?

                                 ______
                                 
 Prepared Statement of Hon. Eliot Engel, a Representative in Congress 
                       from the State of New York

    Mr. Chairman--I think it fair to start by asking--does the 
telephone industry look anything like we thought it would when we 
passed the 1996 Act?
    We thought we were passing one of the biggest reforms in 
Telecommunications law ever. In some ways we were and in other ways--
the 1996 was already old technology. The fact is, the 1996 Act's 
sections on the Telephone industry were written for an analog world--
but today's its all bits and bytes, ones and zeroes.
    Even more amazing is the variations in methods for communicating 
are occurring. We realized in 1996 that the cellular telephone industry 
would be taking off.
    But, did anyone here think that cell phones with digital cameras in 
them would be one of the hottest products?
    Did we think that a large number of our own staffers would forgo 
having a wireline home phone in favor of just a cell phone?
    We certainly didn't foresee being able to plop down at Starbucks 
with a laptop and surf the Internet at speeds much higher than 56k!
    At least the Subcommittee's title has been changed to recognize 
this new world.
    We now are on the verge of radically changing how voice 
telecommunications are handled in our country and our world. I am 
beginning to think we need to change our laws as well. What those 
changes will look like are important to provide clarity and surety to 
this industry and its investors.
    To be successful as legislators and thus allow the industry to grow 
and thrive, we must do our best to provide a level playing field. We 
must ensure that if we do have regulations, they apply equally to all 
participants and do little to get in the way of these industries 
developing new and better products.
    Now, quite frankly, even a year ago, I am not sure I had really 
ever heard the phrase ``Voice over IP''--I did know some people were 
using the Internet to make voice calls, but I didn't realize how 
quickly this technology was developing.
    I have reviewed a tutorial on VoIP done by the International 
Engineering Consortium--and it is quite good. I am greatly impressed at 
how companies are using their intranets to place long distance calls--
often international calls and, in so doing, bypassing long distance and 
international charges.
    I also have become aware that as fast moving as this technology is, 
it is not quite ready for ``prime time.''
    I would like to read a section from the International Engineering 
Consortium's paper, which states:
        The ultimate objective of Internet telephone is, of course, 
        reliable, high-quality voice service, the kind that users 
        expect from the public switched telephone network. At the 
        moment, however, that level of reliability and sound quality is 
        not available on the Internet, primarily because of bandwidth 
        limitations that lead to packet loss. In voice communications, 
        packet loss shows up in the form of gaps or periods of silence 
        in the conversation, leading to a clipped-speech effect that is 
        unsatisfactory for most users and unacceptable in business 
        communications.
    I tend to think of this in terms of talking with my children. More 
specifically, I don't want my son to be able to use the excuse that he 
didn't hear me tell him to do his homework and have that be true!
    I do want to be clear that regardless of what regulatory scheme 
develops for VoIP, I believe that we must move quickly to ensure that 
CALEA applies and also that these services are handicapped accessible.
    I yield back.

    Mr. Upton. Well, we are delighted to have the four 
witnesses that we have this afternoon. We are joined by Mr. 
Michael Balhoff. Is that correct? Did I say that right? 
Managing Director of the Telecommunications Group for Legg 
Mason; Mr. Frank Louthan, VP of Equity Research, Raymond James 
Financial, Inc.; Mr. Adam Quinton, Managing Director and First 
Vice President, Co-Head of Global Telecom Services Research for 
Merrill Lynch; and Mr. Ned Zachar, Founding Partner of Weisel 
Partners, Director of Telecom Services Research from New York.
    Gentlemen, I appreciate very much that you provided your 
testimony last--at least, I was able to look at it last night. 
It is made part of the record in its entirety, and I would also 
note that I am going to ask unanimous consent that those 
members that are not here wishing to make an opening statement, 
their statements will appear as part of the record as well. But 
your statements are part of the record.
    We would like you to take 5 minutes each to summarize your 
remarks, and at that point we will go into questions from 
members of the panel.
    Mr. Balhoff, we will begin with you.

     STATEMENTS OF MICHAEL J. BALHOFF, MANAGING DIRECTOR, 
TELECOMMUNICATIONS GROUP, LEGG MASON INC.; FRANK LOUTHAN, VICE 
PRESIDENT, EQUITY RESEARCH, RAYMOND JAMES FINANCIAL, INC.; ADAM 
 QUINTON, MANAGING DIRECTOR & FIRST VICE PRESIDENT, CO-HEAD OF 
 GLOBAL TELECOM SERVICES RESEARCH, MERRILL LYNCH & CO., INC.; 
  AND NED P. ZACHAR, CFA, FOUNDING PARTNER, WEISEL PARTNERS, 
       DIRECTOR OF TELECOM SERVICES RESEARCH, LEVER HOUSE

    Mr. Balhoff. Thank you very much. Chairman Upton, Ranking 
Member Markey, members of the subcommittee, good afternoon, and 
thank you for the opportunity to address you concerning the 
state of telecom competition.
    I am Michael Balhoff. I am a resident of Maryland. I head 
Telecom Equity Research at Legg Mason. I cover equities in the 
local exchange area. So that is my area of expertise, plus 
rural telephone companies, which have been a particular area of 
focus.
    I am honored to present to the subcommittee on issues that 
I consider to be very important and, obviously, have been 
summarized well by those of you who clearly understand the 
issues that are there, that have changed so significantly since 
1996.
    I believe that the insight that you have previously 
articulated in your invitation to me and to those who are part 
of this panel is correct, that advances in technology have 
spurred significant intermodal competition and that the 
intensity of that competition is likely to accelerate.
    I have five basic points that I have detailed in the fuller 
testimony that I supplied several days ago to the subcommittee.
    First, I believe that competitive activity is very 
significant in the enterprise or the business marketplace. The 
recent FCC data that pertained to last June 2003 indicated that 
CLECs had penetrated on average 23 percent of the U.S. business 
lines, and it is my belief that that number is significantly 
higher, possibly above 40 percent in certain denser business 
marketplaces.
    In the residential market, it is a bit different. I believe 
most investors, or the ones that I talk to at least, know that 
there has been relatively little investment by the so called 
competitors, and most of those investors believe that copper 
based competitors are likely to fade when regulation no longer 
supports the deep discounting that has been put in place by the 
regulators.
    The reason is that the copper based telephony market is not 
naturally as attractive for a telephony-only competitor, and 
the market may not in fact be able to sustain multiple asset 
based telephony-only competitors.
    It appears that we have a system in effect from a financial 
point of view in which there is disintermediation of the 
investment of the LEC shareholders, at least in the current 
regime, and to at least some of the competitors and--this is 
important--without achieving the concomitant public policy goal 
of longer term competitive activity. However, not all is dire.
    My third point is that, while competition is not occurring 
in the regulatory sponsored system that we have put in place, 
at least for the residential marketplace, I believe that 
competition is occurring and is likely to accelerate in the 
intermodal form in a residential market.
    It is already doing that, as has been noted by some of you, 
through wireless high speed data services and cable telephony, 
and the statistics are relatively clear that, while the local 
exchange telephone companies in the reports that they issued 
last week were indicating that their retial residential lines 
were falling off by a rate of 7 to 8 percent, very 
significantly, the reality is that we are seeing significant 
new growth on the side of the wireless phones.
    So we have 157 million wireless phones against 185 million 
wire line phones. We are adding about 4 million wireless 
subscribers on a quarterly basis, and well over 2 million high 
speed customers, both DSL and cable modem customers, on a 
quarterly basis, all at the same time that we are seeing the 
wire line phones contract by about 2 million quarterly. So 
there is a significant migration that is going on that is 
clearly intermodal.
    At this point circuit switched cable telephony is relative 
nascent at 3 million subscribers and, as I indicate in my 
testimony, I don't think that cable telephony in the circuit 
switch sense is going to be that significant. It now accounts 
for about 2 percent of the switched access base.
    My fourth point is that my conviction is that investors 
expect that the real residential voice competition is about to 
come, and it is about to come through voice over internet 
protocol, which we expect to have a transforming effect on the 
telecom marketplace, and very rapidly.
    Notably, the statistics form the cable operators such as 
Time Warner Cable indicate that the penetration rates of Voice 
over IP is likely to reach 5 percent or even higher in the 
first year that the service is provided, and that is based on 
the results from the test market in Portland, Maine.
    It appears that within 2 years we could see residential 
competitive statistics that bypass the numbers that have been 
supplied to us by the regulators or the regulatory induced UNE 
and UNE-P regime for the residential markets.
    My fifth point is somewhat stronger, and this is my final 
point. That is that some investors believe that there is risk 
that we actually could be returning to a monopoly system, and 
the monopoly system, counterintuitively, is actually the cable 
plant.
    The reason is that the cable plant is better suited to the 
high speed types of services that consumers are looking for, 
and Voice over IP gives them a significant advantage. The issue 
becomes even more pointed if the LECs, in my opinion, do not 
invest, and most of them are wrestling with these issues.
    No. 1, they are saying to themselves that the return on the 
investment for this very expensive investment--we are not sure 
that it is there. So different ones of the LECs feel this more 
strongly, but virtually all of them are uncertain.
    Second, they consider the regulatory issues that are out 
there have created an uneven playing field with respect to 
investment, and the concern on the part of the LECs is that 
they are going to have to discount or at least their network to 
competitors and, therefore, the return on investment will not 
be commensurate with what they put into it.
    Finally, almost certainly, the LECs are dealing with a 
situation in which they are going to be vulnerable, because it 
is going to take time to build that network. I am not taking 
sides, and I don't believe any of us should, but the commentary 
that Mr. Markey and various others have offered is that we are 
in an environment where we want more rather than lesser 
competition.
    So I think it is going to be extremely important for this 
committee and for the Members of Congress to look at how 
investment is truly incented and we do not impair any of the 
asset based competitors that are out there.
    I thank you for the opportunity to present to you, and I 
welcome your questions.
    [The prepared statement of Michael J. Balhoff follows:]

Prepared Statement of Michael J. Balhoff, CFA, Legg Mason Wood Walker, 
                                  Inc.

    Chairman Upton, Ranking Member Markey, members of the subcommittee, 
good afternoon and thank you for the opportunity to address you 
concerning the state of telecommunications competition and the growth 
in intermodal communications services. Let me state at the outset that 
my testimony today represents my opinion and does not necessarily 
reflect the views of Legg Mason or the other telecommunications 
analysts at our firm.

        FOCUS OF TESTIMONY ON STATE OF COMPETITION IN DOMESTIC 
                           TELECOMMUNICATIONS

    I am honored to present to the Subcommittee on Telecommunications 
and the Internet about the developments related to competition in the 
communications industry. My understanding is that you wish to better 
discern how much the voice and data markets in the United States have 
evolved over the last several years and how much they are likely to 
continue to change in the foreseeable future.
    I believe that the insight you have previously articulated in your 
invitation to me is correct--that advances in technology have spurred 
significant intermodal competition and that the intensity of 
competition is likely more widespread than many observers realize. I 
will state in my testimony that . . .
    I believe competitive activity is significant in the business 
community;
    Investors believe, in my opinion, that the current deep discounting 
in the residential market has created competitive statistics that are 
higher than most investors are willing to believe, and fund managers 
are generally unwilling to commit long-term capital to a system that 
they perceive as often based on regulatory arbitrage;
    I believe that competition, however, is occurring in intermodal 
form in the residential market through wireless, high-speed data 
services, and cable telephony;
    My conviction is that investors expect that the voice services 
provided by cable operators based on Internet Protocol will have a 
transforming effect on the telecommunications market within a few brief 
years; and
    The current risk is that we eventually could be returning to a 
monopoly system owned by the cable operators if the local exchange 
carriers (LECs) are unable or unwilling to invest in the longer-term 
network because: (1) the expense of the investment in high-speed 
network is too high to generate a satisfactory return, (2) there is too 
much uncertainty or fear about rules requiring them to share their 
investment with competitors, or (3) the time required in the investment 
will be too extended.
    In support of my views, I will briefly summarize publicly available 
data on: (1) ILEC (incumbent local exchange carrier) and CLEC 
(competitive local exchange carrier) voice marketshare for business and 
residential, (2) wireless service as a substitute for the local 
exchange service, (3) broadband market growth and the unique factors 
affecting the competitive landscape of cable-modem services and digital 
subscriber line services, and (4) cable companies' progress in 
capturing voice telephony market share based on circuit-switched and 
voice over Internet Protocol (VoIP) technologies.

                  LOCAL EXCHANGE CARRIER MARKET SHARE

    One of the key goals of the Telecom Act of 1996 was the 
introduction of competition in the urban local exchange market. Most of 
the statistics from the FCC and the investment community verify that 
this goal has, in part, been achieved and that a significant number of 
customers are served by alternative local exchange service providers 
over the traditional telephony network, notably in the business 
marketplace. The FCC, the state regulators, and the courts have 
accomplished much of this task by setting myriad rules and 
clarifications for leasing the incumbent's network elements, incenting 
significant new investment by competitors, sifting through 
controversies related to arcane subjects such as collocations, hot-
cuts, cost models and the long-distance Section 271 process. We have 
far more insight today into the legalities and technologies of 
communications than those policymakers had in the mid-to-late 1990s, 
but the end result is that they made possible real competitive growth. 
Illustrating the general trend toward competition, the most recent FCC 
data suggest that total CLEC market share has increased to 15% in June 
2003 from 4% in December 1999. Table 1 summarizes the data, with the 
statistics representing that the incumbent carriers' share of the total 
lines has slipped in the same three-and-a-half-year period to 85% from 
96%.

                                         Table 1: FCC Market Share Data
----------------------------------------------------------------------------------------------------------------
                                                   ILEC Market Share                   CLEC Market Share
                                         -----------------------------------------------------------------------
                                          Total  Res/    Total                Total  Res/    Total
                                           Sm.  Bus.   Business    Total LEC   Sm.  Bus.   Business    Total LEC
----------------------------------------------------------------------------------------------------------------
December-99.............................       97.6%       89.6%       95.7%        2.4%       10.4%        4.3%
  June-00...............................       96.8%       84.9%       94.0%        3.2%       15.1%        6.0%
December-00.............................       95.4%       82.5%       92.3%        4.6%       17.5%        7.7%
  June-01...............................       94.5%       80.9%       91.0%        5.5%       19.1%        9.0%
December-01.............................       93.4%       79.2%       89.7%        6.6%       20.8%       10.3%
  June-02...............................       92.2%       77.5%       88.6%        7.8%       22.5%       11.4%
December-02.............................       89.7%       77.7%       86.8%       10.3%       22.3%       13.2%
  June-03...............................       88.0%       76.8%       85.3%       12.0%       23.2%       14.7%
----------------------------------------------------------------------------------------------------------------
Source: FCC data; Legg Mason Wood Walker, Inc.

    I believe that the competitive data are clear that the business 
market share shift has been dramatic. The FCC surveys state that CLECs 
penetrated, on average, 23% of the reported U.S. business lines by mid-
2003. In certain denser business centers, the penetration of business 
lines appears to be above 40%. In short, my view is that, in the wake 
of the Act, competitors have entered a financially attractive market to 
target those customers that could generate reasonable profits in high-
density regions. The result is that businesses now have a variety of 
asset-based competitors from which to choose.
    My view of the residential market is different, and I believe that 
the FCC data lead to more suspect conclusions. The residential market 
share shift occurred later than did the business shift, apparently for 
several reasons. First, residential rates have been maintained at 
relatively low levels and were even subsidized in some regions as part 
of public policy since the early part of the last century. Second, the 
costs associated with providing residential services are high, meaning 
that the profit spread is likely modest at best, which is why we have 
seen little investment on the part of copper-based competitors. Third, 
the usage volumes and mix of services are generally unattractive for 
residential competitors, especially compared with services provided to 
businesses. And, fourth, the investment necessary to provide ancillary 
services--video, high-speed data, etc.--is prohibitive unless the 
communications provider can offer, and have a high probability of 
retaining, a much fuller array of services. More simply stated, the 
residential market is not naturally as attractive for a telephony-only 
competitor, and the market may not, in fact, be able to sustain 
multiple asset-based telephony-only competitors.
    Predictably, some federal and state regulators have been unwilling 
to accept the tenet that competition is not as well-suited to the 
residences of the American public. Recognizing that the task they faced 
was complex and the goals worthy, regulators therefore chose to 
intervene, using a model that was similar to the one employed in the 
successful breakup of the long-distance monopoly market in the 1980s. 
Based on that model, state and federal regulators have required the 
incumbent to lease its network at deep discounts, which were far more 
complex in their formulation than the long-distance intervention in the 
1980s. Sometimes the rates were set at very low levels and at other 
times they were fixed somewhat higher to incent competitive investment. 
In general, the TELRIC (total element long-run incremental cost) 
pricing model--using marginal costs analyses--assumed that, when the 
competitors were able to gain enough scale, they would build a newer, 
more modern stand-alone network. The goal was, like that of the simpler 
long-distance industry in the 1980s, the nurturing of real businesses, 
characterized by real assets and profit margins in the form of a 
sustainable business model.
    Unfortunately, there appears to be virtually no such investment 
occurring on the part of copper-based competitors in the residential 
market because the premise was flawed. The miscalculation arose because 
investment costs and risk are very high in the residential local 
exchange business, especially compared with the relatively less 
expensive assets required to serve the 1980s' long-distance market, and 
the profit margins on LEC businesses are thinner and are probably not 
sufficient to sustain the higher levels of investment. Accordingly, 
today we have more ``competitors'' offering residential local exchange 
services based on regulatory approaches that, however well-intentioned, 
have not spurred viable long-term enterprises.'' In fairness, there 
were some competitors that tried to invest, but some have admitted that 
they were disadvantaged by a system in which TELRIC competitors had a 
more attractive short-term business proposition with virtually no 
capital costs and lesser competitive risk. In sum, we committed to a 
system in which there is disintermediation of the investment of the LEC 
shareholders into at least the some of the competitors without 
achieving the concomitant public policy goal of longer-term competitive 
activity. Worse, we may have a system that is draining cash flows from 
viable competitors--the LECs--precisely at the moment when they need to 
invest in order to withstand the next stages of formidable intermodal 
competitive activity from attractive wireless and cable-based services.
    My view, then, is that we have been through a period of illusory 
business propositions that have burst badly, and we may have new 
illusions, including the less-than-convincing policy that the 
telephony-only POTS-like model can be competitive for residential 
customers. More directly stated, in the residential market, I believe 
that the only major facilities-based competitors in the U.S. are the 
wireless carriers and the cable operators, whose plant already exists 
or is in need of some relatively modest upgrade.  Thus, the statistics 
tabulated about residential competition are, in the minds of investors, 
not representative of the underlying reality.
    I believe that competition is, in fact, occurring, but it is 
through a fundamental intermodal shift, transpiring with the advent of 
new technologies and marketing.

             WIRELESS AS A SUBSTITUTE FOR WIRELINE SERVICE

    Clearly, wireless is an important source of competition. In fact, 
investors and analysts ask about wireless substitution on virtually 
every investor communications-related conference call. As analysts, we 
track the falling numbers of LEC access lines that can be fully 
explained only by reality of competitive choice, including wireless. We 
analyze the innovative types of services that appear increasingly 
attractive because they offer new features, including mobility, text 
messaging, image generation, etc. My observation is that policymakers, 
understandably, work within legacy constructs--including statutes and 
case law--that define wireless and other intermodal services as 
different from traditional telephony, and some policymakers have been 
slow to embrace intermodal services as competitors. At the same time, I 
believe firmly that those newer carriers, based on proven alternative 
technologies, are formidable competitors precisely because their 
products are different from copper-wired services.
    Let us take a brief look at some statistics related to wireless. I 
note that, while it is clear that there is substitution whereby 
wireless-only customers may be 8% of the total consumer market today, 
it is admittedly difficult to calculate precise figures. To provide 
some insight into the data, however, we can examine recent reports of 
the Bell companies. Each of the carriers supplies information in 
formats different from the others, and the data are often different 
from the information supplied by that very carrier in the previous 
quarter, making analysis a bit tricky. In the most recent quarter 
reported last week, for example, SBC supplied interesting statistics to 
illustrate the company's improving performance in terms of line loss in 
certain of its service regions. In Table 2, the data are totaled and 
analyzed in a way different from SBC's presentation to investors, 
highlighting that the company was not doing quite as well as the 
initial investor slides depicted. While the company was posting lesser 
line losses in sequential quarters in terms of primary lines and second 
(also called ``additional'') lines, further analysis revealed that the 
net losses are actually growing in a way that cannot be explained 
solely by regulatory-imposed discounting rules. Using the company's 
data on residential lines--primary and additional--and subtracting them 
from the gains in wholesale lines, which are unbundled connections 
leased to competitors, the summation suggests that the total of retail 
and wholesale residential lines is contracting more rapidly in the last 
two quarters of 2003. I note that the wholesale data used in this 
analysis includes both residential and business lines, but I believe 
that the residential wholesale lines are growing at least as fast as 
the business lines, and that the conclusion is still the same. In the 
case of BellSouth, the company reports simply that it lost 7.3% of its 
retail lines year-over-year and that the net loss of retail lines, 
offset by wholesale gains, was 3.1%. BellSouth's absolute losses in 
residential lines--combined retail less wholesale--in the fourth 
quarter were 134,000, slightly worse than the 130,000 lost in the third 
quarter. Verizon does not supply the data necessary to perform a 
similar calculation. What is the explanation flowing from these 
statistics? Substitution continues unabated.
    Looking carefully at the analysis, however, reveals something more 
about wireless. First, the total residential loss can be explained, in 
part, by the shifting to cable modems or DSL, but data substitution is 
generally a second-line phenomenon, and the second-line loss is slowing 
and is well below the total loss. It does not seem that the loss is due 
to a more severe economic downturn, as the economy appears to be 
improving, nor does the loss appear to be due to the shift to cable 
telephony, as those forces are still relatively nascent. It appears to 
me that the higher losses are due to an acceleration in the movement 
toward wireless services and away from wireline telephony.

                                  Table 2: SBC Quarterly Residential Line Loss
                                                 (in thousands)
----------------------------------------------------------------------------------------------------------------
                                                                  1Q03         2Q03         3Q03         4Q03
----------------------------------------------------------------------------------------------------------------
Residential primary lines...................................       (504)        (479)        (378)        (228)
Residential second lines....................................       (236)        (229)        (229)        (170)
Residential total losses....................................       (740)        (708)        (607)        (398)
Wholesale net adds (business + residential).................         684          665          375          116
Net line loss (residential total + wholesale)...............        (56)         (43)        (232)        (282)
----------------------------------------------------------------------------------------------------------------
Source: SBC data; Legg Mason Wood Walker, Inc.

    Legg Mason has published in the past that we estimate that roughly 
one half the residential line loss is the result of consumers' cutting 
off slow circuit-switched second lines to migrate to high-speed data 
substitutes, and that approximately 25% of the share shift was due to 
consumers' substituting into wireless services. The data now suggest 
that the trend toward wireless is accelerating, as cellular price plans 
and convenience have occasioned the growth of wireless to approximately 
157 million subscribers at the end of the fourth quarter compared with 
approximately 185 million wired telephone lines, by Legg Mason 
estimates.
    Table 3 provides wireless customer additions by carrier for each 
quarter since the beginning of 2002. The key messages are that the last 
three quarters have been marked by solid sequential growth in 
additions, that the strong wireless carriers have tended to gain share, 
and all this is occurring at a time when the RBOCs are reporting sharp 
year-over-year retail residential declines. The comparisons are 
startling--SBC reported 8.0% retail residential losses in the final 
quarter of 2003 compared with 2002, while BellSouth disclosed 7.3% 
contraction (cited earlier), and Verizon announced only the combined 
wholesale and retail slippage of 3.7%, meaning that the retail loss was 
likely more severe. With the introduction of wireless local number 
portability in late November 2003--permitting a wireline customer to 
port its number to a wireless carrier--it seems that the regulators 
have moved closer to stating that they view wireless as a substitute 
for wireline access that was once judged to be an imposing bottleneck.

                                Table 3: Quarterly wireless subscriber additions
                                                 (In thousands)
----------------------------------------------------------------------------------------------------------------
                                           1Q02A    2Q02A    3Q02A    4Q02A    1Q03A    2Q03A    3Q03A    4Q03E
----------------------------------------------------------------------------------------------------------------
Verizon Wireless........................      186      723      803      964      755    1,214    1,407    1,496
Cingular Wireless.......................      234      353     -107     -121      189      540      745      642
AT&T Wireless...........................      650      417      201      705      283      446      229      128
Sprint PCS..............................      725      308      -78      250      199      360      184      390
Nextel..................................      502      471      480      503      480      591      646      549
T-Mobile................................      509      453      869    1,017      921      606      670    1,015
                                         -----------------------------------------------------------------------
                                            2,806    2,725    2,168    3,318    2,827    3,757    3,881    4,220
----------------------------------------------------------------------------------------------------------------
Source: Company data; Legg Mason Wood Walker, Inc.
Figures from Verizon, AT&T Wireless and T-Mobile for 4003 are actual.

                        BROADBAND MARKET GROWTH

    The growth in broadband services--primarily based on cable modems 
and DSL--continues to accelerate for residential and business 
customers. Table 4 details DSL data from the three-largest telephone 
companies, highlighting the quarterly increases in total lines served 
by the carriers and the increases in net additions each period. The 
increases have been gradual, but they are increases nonetheless, again 
over and against the RBOC line losses. In terms of the numbers of 
customers subscribing to DSL each quarter, the three-largest Bells 
report 706,000 new lines added in the fourth quarter of 2003--announced 
in the last week--following 661,000 in the preceding period and 508,000 
in the three months before that.

                                 Table 4: RBOC Quarterly DSL Totals and Net Adds
                                                 (in thousands)
----------------------------------------------------------------------------------------------------------------
                                            1Q02     2Q02     3Q02     4Q02     1Q03     2Q03     3Q03     4Q03
----------------------------------------------------------------------------------------------------------------
Verizon DSL lines.......................    1,336    1,485    1,640    1,788    1,830    1,931    2,116    2,319
  Net adds..............................      148      149      155      148      160      101      185      203
SBC DSL lines...........................    1,515    1,728    1,954    2,199    2,469    2,773    3,138    3,515
  Net adds..............................      183      213      226      245      270      304      365      377
BellSouth DSL lines.....................      729      803      924    1,021    1,122    1,225    1,336    1,462
  Net adds..............................      109       74      121       97      101      103      111      126
----------------------------------------------------------------------------------------------------------------
Total DSL lines.........................    3,580    4,016    4,518    5,008    5,421    5,929    6,590    7,296
Total DSL adds..........................      440      436      502      490      531      508      661      706
----------------------------------------------------------------------------------------------------------------
Source: Company data; Legg Mason Wood Walker, Inc.

    The cable operators have also reported high-speed data growth, with 
the absolute number of additions generally rising. Figure 1 illustrates 
the subscriber quarterly additions, based on the companies that Legg 
Mason follows and our estimates of the other carriers. Notably, the 
cable operators continue to attract more subscribers in absolute terms 
each quarter compared with the DSL additions by the Bell companies and 
the additions by all LECs.
    An alternative view is based on Legg Mason's estimates of the high-
speed market share as illustrated in Figure 2. The graphic conveys the 
commanding market leadership of cable operators in this expanding 
communications segment. At the same time, we estimate that cable share 
has slipped to approximately 57% in the final quarter of 2003 from 
about 68% in the first quarter of 2003, with the major reason being the 
gradual pressure from RBOCs--much lower rates, better bundling, and 
more widespread availability--that appear to be focused on retaining 
high-speed share lest the Bells be disadvantaged when the cable 
operators begin offering VoIP services in 2004 and beyond. 
Additionally, the independent local exchange carriers have gained 
share, particularly in markets that are not as well served by cable 
operators.

[GRAPHIC] [TIFF OMITTED] T2536.001

[GRAPHIC] [TIFF OMITTED] T2536.002


    In our consultations with investors and regulators over recent 
months, I have suggested that the expanding battle over high-speed data 
is the thunder in the distance before the most formidable storm of 
intermodal competition is upon us. My view is that the Bells recognize 
that the true residential competition is about to break out and 
competitive activity, ironically, has nothing to do with what the deep 
discounts or other temporary constructs that regulators have employed 
in attempting to change what has for so long been an intractable 
residential marketplace.

                      CABLE OPERATORS' VOICE SHARE

    At present, competition from cable operators is relatively limited, 
as Cox and Comcast have some circuit-switched customers, but few other 
cable operators have invested in cable telephony. The most recent FCC 
competitive statistics, as of the end of June 2003, contend that there 
were approximately 3.0 million cable telephony lines in the United 
States, accounting for about 11% of CLEC lines and 2% of the total 
domestic switched access lines. I believe the statistics are 
interesting, but do not merit much study because the true intermodal 
cable product is already making its entrance in the form of voice over 
Internet Protocol.
    My view that most telephony investors are profoundly concerned 
about VoIP competition is evidenced by the fixation on the competitive 
share shift generated by tiny providers such as Vonage, Net2Phone, 
Skype and Pulver.com. Investors follow every signal from the cable 
operators that are market-testing VoIP and those that have begun to 
roll out the Internet-based service. Among the cable operators, 
Cablevision and Time Warner Cable are being watched most carefully, as 
they are offering widespread service earlier than their peers.
    The power and speed of the rapidly approaching weather system was 
driven home last week (January 28) when Time Warner reported on its 
test market in Portland, Maine. The service was begun in May 2003, a 
mere nine months ago, and management reports that it has captured more 
than 10,000 VoIP customers, which is about 23% penetration of the high-
speed customer base, 9% of the company's video customers in the region, 
and, by Legg Mason's estimate, 5% of the homes passed in Portland. The 
company also reported it was beginning to offer VoIP in Kansas City, 
Kansas, and Raleigh, North Carolina, and expected, by the end of the 
first quarter, to have service in a total of six of the company's 31 
systems across the country, and, by the end of 2004, to have service in 
virtually its entire cable footprint.
    If we compare Time Warner's penetration rate to the FCC competition 
statistics cited at the outset, I suggest that Time Warner could be 
near 5% residential penetration within its first year of service, 
adjusting for the fact that the company's homes-passed are fewer than 
the residential telephony lines in the region. Notably, the FCC reports 
that residential plus small business penetration of CLECs is 12% as of 
June 2003, based significantly on the discounted rates the regulators 
set. It appears that, within two years, we could see the residential 
competitive statistics bypassed by VoIP services in a marketplace that 
is fundamentally driven by technology changes, and a result 
accomplished far more effectively than might have been expected through 
regulatory incentives.
    I believe that the introduction of VoIP services will move 
residential competition to a place that legislators and regulators 
could not have expected realistically under the copper-based telephony 
model. In this new intermodal competitive landscape, consumers will be 
able to choose from asset-based competitors whose services are 
differentiated from, and more convenient than, circuit-switched 
telephony. Further, the pricing for services will almost certainly, in 
my view, be more attractive than rates possible using legacy telephony, 
because of the underlying economics of Internet-based technologies.
    Another sign that the intermodal forces are significant is apparent 
in reviewing the RBOC responses. The storm is so fearful that the RBOCs 
are vigorously preparing for its onset by slashing pricing for their 
DSL services, sharpening their marketing on bundled services, 
pressuring equipment vendors to develop high-speed electronics in 
volumes at dramatically lower prices (deployment has yet to occur 
except in tests), and at least generically announcing VoIP products for 
businesses and residential customers.

                     FUTURE-ORIENTED POLICY ISSUES

    As I summarized at the outset, I believe that the emerging 
intermodal forces raise serious policy questions. Regulators and 
legislators will increasingly have to consider whether the incentives 
and constraints that they are employing are dismantling the correct 
bottleneck monopoly in light of the rapidly changing technologies. In 
fact, I believe that many of the more thoughtful policymakers recognize 
that backward-looking schemes are seriously limiting RBOC investment 
and that the limitations could have unintended consequences in causing 
the LECs to slow their commitments to the forward-looking wireline 
markets in which fiber and optical electronics are key.
    I do not propose that there are simple answers to these questions, 
but I have written and believe firmly that competition is unfolding in 
an intermodal world and that the RBOCs may not be able to reshape their 
services rapidly enough. It is clear to me that the RBOCs are 
conflicted about whether their investment expenditures are too high to 
justify widespread deployments. They are uncertain about whether 
alternative investments such as fiber-to-the-curb make more economic 
sense, but there is too great a risk in a world in which the rules 
promise that competitors will not dilute that investment if, and only 
if, the investment is all the way to the premise. And the RBOCs appear 
to me to be wrestling with the reality that the rebuild will be time-
consuming, raising the possible evaluation of an alternative financial 
model in which the RBOCs admit that their securities are inevitably 
declining annuities, which is to say that they cede the emerging 
services to better-prepared asset-based competitors as they more 
responsibly return cash to their shareholders. If that happens, then I 
believe that the new communications marketplace could be served by 
alternative services that may be monopoly-like because the investment 
required to compete is so great.

                               CONCLUSION

    To summarize my testimony, I note that there are key points for 
this Subcommittee's reflection.
    My simple observation as an analyst is that competition has 
generally worked where there are fundamental financial realities to 
support businesses.
    In the enterprise and small business markets, competitive growth is 
significant, with competitive penetration over 30%.
    Over and against that, in the residential market, I see a short-
term competitive model that is understandably policy-oriented, but I 
believe that ``competition'' in the wireline copper-based telephony 
market will dissipate when the artificialities are removed within the 
next several years.
    At the same time, it appears to me that the tenet in sponsoring 
this Subcommittee's discussion is correct--that competition is 
unfolding through intermodal services, including wireless, broadband 
communications such as email, and, most importantly, through the very 
obvious and formidable threat of VoIP.
    If investors have a concern, I believe it is that they are fearful 
that some policymakers misunderstand the nature of how competition 
unfolds, and that the natural competitors in the various marketplaces 
are constrained because cash flows and returns on capital commitments, 
in the case of the RBOCs, are uncertain precisely at a time when 
investment is necessary to cope with intermodal competitive threats.
    Thank you for the opportunity to present my views.

    Mr. Upton. Thank you very much.
    Mr. Louthan.

                   STATEMENT OF FRANK LOUTHAN

    Mr. Louthan. Good afternoon. Mr. Chairman and distinguished 
members of the subcommittee, thank you very much for allowing 
me the opportunity to discuss my views on the state of 
competition within the telecom industry.
    My name is Frank Louthan, and I am the Senior Wire Line 
Analyst in the Telecommunications Group at Raymond James. The 
majority of my testimony will center around the current state 
of competition in the telecommunications industry and how it 
relates to regulations and investors.
    I would like to focus on the convergence of service 
provider offerings that are blurring the lines between local, 
long distance, wireless and data services, and especially the 
ensuing intermodal competition, as I believe the regulatory 
community should be aware of the impact these trends will have 
on the industry participants, investors and consumers.
    Local voice has become a commodity with IXCs and CLECs 
attacking the mass market, largely as UNE providers, cable 
operators rolling out switched and Voice over IP services, and 
emergence of wireless' land line and long distance substitutes, 
which I will touch on later.
    Other factors impacting local telephone companies include a 
decline in second lines in favor of broadband connections and 
the replacement of primary and secondary lines by wireless 
phones.
    The influx of competitors following the Telecom Act in 1996 
fueled by a rising market led to a variety of telecom 
strategies and assets being deployed and significant 
competition into every corner of the market. The other less 
obvious result has been the erosion of the health of the 
industry as these competitors all seek to cover their high 
fixed costs with lower and lower contributions form incremental 
sales.
    The real issue, in my opinion, gets down to the economics 
of the business, which I believe to be largely fixed, thus 
making it difficult for multiple network providers in the same 
market to generate positive returns. High fixed costs can 
create high incremental margins and significant profitability 
over time, although this should not necessarily be mistaken for 
an open invitation in every market for competitors to enter, as 
profits may erode quickly in the face of multiple providers.
    Eroding profits, in turn, provide disincentives to 
investors, which I view as a negative scenario in a capital 
intensive industry such as telecommunications. Meanwhile, 
regulation has generally discouraged more investments in 
important areas such as the ``last mile.''
    The investment community is largely uncomfortable with 
continued erosion in the fundamentals and has a general lack of 
comfort with the regulatory environment. With some level of 
competition, I believe that the incumbent providers and new 
entrants are kept on their toes, innovation ensues, and pricing 
is definitely kept at a lower level than under a monopoly 
regulated regime. However, the current state of the industry is 
generally regarded as unhealthy, as carriers are seeing their 
returns decline, and investors are growing less likely to 
participate in an industry that is perceived to be becoming 
irrational.
    The wire line industry faces several modes of voice 
competition, the most high profile of which remains UNE-P 
followed by cable. The cable companies have had great success 
in deploying facilities based broadband services, and I expect 
them to take a meaningful share of the voice business over time 
through bundles and innovation, plus they benefit from 
favorable regulation.
    Another issue that should be considered in the fallout of 
increased telecom competition is the erosion of access minutes 
of use. This revenue stream is an implicit subsidy for many 
telecom providers and important to their health, not to mention 
the support of the telecom infrastructure covering a large 
portion of the U.S.
    Broadening the use of cell phones as the primary vehicle 
for long distance calling has significantly reduced access fees 
and long distance revenue. I estimate the network access and 
long distance represent anywhere from 20 to 60 percent of total 
revenue for RBOCs and rural ILECs, and the network access 
erosion has yet another subtle impact of intermodal competition 
that should be addressed.
    Over time, I believe 10 to 15 percent of households could 
disconnect their primary phone, land line phone, for a wireless 
phone, with acceptance of lower voice quality in exchange for 
lower cost being the key driver of this dynamic. Overall, I 
believe wireless substitution will be a secular trend that 
continues in the industry for sometime and which will have a 
larger impact on primary and secondary access lines in urban 
markets and a corresponding impact on long distance revenue and 
access revenue in rural markets.
    In summation, the lines are becoming increasingly blurred 
in the eyes of consumers with regard to the medium with which 
they are receiving their telecommunications services in the 
residential market. Yet regulation has generally been enacted 
without considering the broader market for telecom services, 
particularly whether or not customers have some alternative 
form of service, regardless of the technology or device 
employed.
    I do not believe residential or business customers suffer 
from a lack of choice in telecommunications services, a 
situation I do not see changing anytime soon. Hence, the total 
impact of all mediums of the competition and consumers' 
indifference between them should be strongly considered in the 
continuation and modification of telecom regulation.
    Thank you for your time, and I look forward to your 
questions.
    [The prepared statement of Frank Louthan follows:]

     Prepared Statement of Frank Louthan, Senior Wireline Analyst, 
                Telecommunications Group, Raymond James

    Mr. Chairman, and distinguished members of the subcommittee, thank 
you very much for allowing me the opportunity to discuss my views on 
the state of competition within the telecom industry. My name is Frank 
Louthan, and I am the senior Wireline Analyst in the Telecommunications 
group for Raymond James. The majority of my testimony will center 
around the current state of competition in the telecommunications 
industry and how it relates to current regulations and investors.
    Convergence of services, providers, and service offerings are all 
blurring the lines between local voice, long distance voice, wireless, 
data, and video services. We see technological barriers becoming weaker 
and competition for these services increasing. As the RBOCs integrate 
their offerings with satellite providers through joint ventures, the 
cable operators roll out telephony services, wireless data becomes a 
larger mass-market offering, and other new technologies complicate 
matters further, we believe the regulatory community should be aware of 
the impact these trends will have on the industry participants, 
investors, and consumers.
    While local voice services were historically dominated by the local 
Bell monopolies, these services are now experiencing a higher degree of 
competition from a number of sources. IXCs and CLECs are attacking the 
mass market largely as UNE providers, although this source of 
competition has higher concentrations in states with lower UNE rates. 
Cable operators are increasingly rolling out switched voice services, 
although their mass roll-out has been somewhat limited thus far as they 
wait for VoIP (voice over Internet Protocol) to become more of a 
reality. Other factors impacting local telephone companies include a 
decline in second lines as consumers abandon them for a broadband 
connection or wireless phone, and the replacement of primary lines by 
wireless phones as that technology becomes a more ubiquitous service.
    The overexuberance of the capital markets following the Telecom Act 
of 1996 created a large influx of competitors using different sets of 
assets to somehow capture revenue from either voice or fast-growing 
Internet services. The result, of course, has been significant 
competition at almost every corner of the industry. The other, less 
obvious result is the erosion of the health of the industry as these 
competitors all seek to cover their high fixed costs with lower and 
lower contributions from incremental sales. The real issue, in my 
opinion, gets down to the general economics of the business, which I 
believe to be largely fixed, thus making it difficult for multiple 
network providers in the same market to generate a positive return. The 
high fixed costs can create high incremental margins and significant 
profitability over time, although this should not be mistaken for an 
open invitation for many competitors to enter the market, as those 
profits erode quickly in the face of multiple providers. Eroding 
profits, in turn, provide disincentives to investors, which I view as a 
negative scenario in a capital-intensive industry such as 
telecommunications. We are currently in a state of industry flux that 
discourages spending on new assets, as the recent large investments in 
capital have not earned returns, thus discouraging innovation from 
telecom equipment providers due to pressure on pricing, revenue, and 
cash flow. Meanwhile regulation has done its part in discouraging 
investment where it can be deployed most effectively, namely the ``last 
mile.''
    I believe there is more competition than necessary in the telecom 
industry at the present time. The investment community is largely 
uncomfortable with spending on new facilities due to continued erosion 
of industry fundamentals and a general lack of comfort with the 
regulatory environment. With some level of competition, I believe 
incumbent providers and new entrants are kept on their toes, innovation 
ensues, and pricing is likely to remain at a lower level than under a 
monopoly-regulated regime. However, the current state of the industry 
is not healthy, as carriers are seeing their returns decline and 
investors are growing less likely to participate in an industry that is 
perceived to be irrational.
    Competition that has been most evident for local, wireline voice 
services to date has been UNE-P competition, which dictates rates 
through state regulatory commissions. Rates are set by theoretical cost 
models, where the incumbent and competitors (along with consumer 
protection agencies) bicker amongst themselves. UNE-P has flourished 
once prices hit a certain threshold; yet we have seen little evidence 
of the providers' desire to build their own facilities, as they are 
earning very healthy returns under the current model. We believe a 
resale business model makes sense in some instances, yet there are too 
many arbitrage opportunities in the marketplace set forth by a 
telecommunications market with no real market-based rates. Such a 
system promotes ``cherry-picking'' attractive customers and neglecting 
others, while reducing the RBOCs' incentives to develop, deploy, and 
sustain new services.
    Meanwhile, as the RBOCs get a firmer handle on UNE-P competition, 
their focus has been shifting to a large degree towards cable 
competition, which will effectively provide real facilities based 
competition regardless of regulations currently in place. Currently, 
the RBOCs are betting their voice/data/wireless/and satellite bundles 
can beat the cable industry's voice/data/entertainment bundles, with 
the ultimate winner of this clash unclear at the present time. However, 
the scales are currently tipped in the cable providers' favor, in our 
opinion, with these companies not having to deal with an out-dated 
regulatory model that is becoming increasingly irrelevant in the face 
of technological innovation.
    A great example of how market-based forces can spur facilities 
creation is the broadband marketplace. Most consumers have at least 2 
choices of facilities based broadband offerings (cable and the 
incumbent telecom provider), with several others that are not 
facilities based. We believe there is sufficient competition that has 
evolved for broadband services between the local cable company and the 
incumbent telecom provider to spur facilities creation, price 
competition, and innovation.
    Cable has done an excellent job of deploying broadband, in the 
process demonstrating how market forces can be the best driver of 
companies bringing new and innovative services to the marketplace. I 
believe this is largely due to the certainty of the investment for the 
MSOs, as they may have been reluctant to roll out a mass broadband 
offering had they been required to resell it under regulatory driven 
rates in a similar manner to the RBOCs. Meanwhile, the RBOCs have 
lagged cable providers in deploying broadband and simply gaining 
customers, in part due to issues with their plant, but also out of 
concerns over stifling regulation, be it either allowing competitors to 
use their facilities or simply paying more attention to their battles 
over voice regulation. Considering the amount of choice customers have 
in broadband, not to mention the nascent wireless data offerings that 
are further changing the game for broadband and data access, regulation 
of this market would simply stifle rather than promote competition over 
the long run, in my opinion.
    When discussing the obvious technological change that is spurring 
real, market-based competition for voice services, VoIP (Voice over 
Internet Protocol) is the largest near-term driver of such forces. Once 
again the cable provider, with plant already deployed and an embedded 
customer base to market the service towards, appears to have an 
advantage. The cable operators have the financial resources, economic 
justification, and expertise to pull-off mass-market offerings that 
should spur competition and new services.
    However, the RBOCs must deal with this market-based competition for 
wireline voice services in addition to devoting resources towards 
regulatory requirements and UNE-P debates. UNE-P providers leverage the 
RBOCs' networks even while the RBOCs must provide universal service and 
lifeline services to unprofitable customers. A large portion of 
incumbent service providers' revenue comes from long distance and 
network access revenue, which is being eroded by wireless and other 
forms of technological substitution. We believe consumers now view 
wireless long distance as free and are therefore more likely to use 
their wireless phone to make long distance calls. This significantly 
reduces both long distance revenue the incumbent can generate or at the 
very least originating access fees. Terminating access fees are also 
being reduced as consumers utilize wireless phones. We note this is a 
key motivator for the RBOCs to roll out any-distance bundles (in 
addition to matching UNE-P competitors products), as they look to 
replace a declining revenue source with a stable, non-usage dependant, 
and possibly increased revenue source. We estimate network access and 
long distance represents between 20% and 60% of total revenue for the 
RBOCs and ILECs, making this revenue source significant. We view this 
as another subtle impact of intramodal competition.
    In addition, wireless phone and increasingly data services are 
becoming very competitive alternatives to wireline voice connections to 
the home. We believe the roughly 9.6% of the population that are single 
between the ages of 20 and 34 are the most likely to disconnect their 
wireline phone for a wireless phone (with a significant proportion of 
this age group having already done so). As young consumers between 15 
and 19 (another 6.6% of the U.S. population) become households, we 
believe these households could become prime wireless substitution 
candidates. At the same time, we believe a portion of these consumers 
are likely to keep phone lines for Internet connections or simply 
choose not to forgo a wireline phone.
    We also believe a large portion of the population that is married, 
currently around 62 million couples (124 million people) or around 58% 
of households are less likely to cut the cord. Factors such as a need 
for common points of contact, wireless handset and battery quality, 
connections to security/monitoring services, and other practical 
limitations of wireless phones are also expected to play a part in 
multiple person households retaining a wireline phone, in my opinion. I 
believe 10% to 15% of households could disconnect their primary phone 
line for a wireless phone, although the speed at which this could occur 
is unclear, and the advance of wireless data options, network quality, 
and changes in consumer preferences are expected to be the gating 
factors. A key change in consumer preference would include acceptance 
of less than ``5-9's'' reliability for phone coverage, which I believe 
is already to emerging, as evidenced by the significant numbers of 
consumers that already view wireless as an acceptable alternative to a 
landline phone.
    The actual impact of wireless substitution is difficult to estimate 
because it is highly dependent on consumer preferences that can change 
over time. However, we believe age and marital status are key factors 
to look at when trying to predict this preference. Other factors 
include wireless coverage, local culture (we believe wireless 
substitution is more prevalent in larger cities than less densely 
populated areas due to better wireless coverage, a larger prevalence of 
wireless phones, and different conventions), customer service, and 
economic factors. We believe wireless substitution will be a secular 
trend that continues in the industry for quite some time, which will 
have a larger impact on second lines, long distance revenue, and access 
minutes of use over the near term.
    In summation, the lines are becoming increasingly blurred in the 
eyes of the consumer toward the medium within which they are receiving 
their telecommunications services in the residential market. Yet 
regulation has generally been enacted without considering the broader 
market for telecom services, particularly whether or not customers have 
some alternative form of service, regardless of the medium. I do not 
believe residential or business customers suffer from a lack of choice 
in telecommunications services, which is a development that will be 
proliferated by the quickening pace of technological innovation in the 
coming years. Hence, the total impact of all mediums of telecom 
competition and consumers' indifference between them should be strongly 
considered in the continuation and modification of telecom regulation.

    Mr. Upton. Thank you.
    Mr. Quinton.

                    STATEMENT OF ADAM QUINTON

    Mr. Quinton. Good afternoon, Mr. Chairman and distinguished 
members of the subcommittee. Thank you for inviting me to 
appear before you to discuss the state of the communications 
market. I am truly honored to be here.
    As a financial analyst, my primary role is to make stock 
recommendations for Merrill Lynch's investor clients. As such, 
my perspective on the telecom industry reflects a mix of 
considerations: The broader industry structure and growth 
outlook; the way factors such as technology change and 
regulation impact the way individual companies participate in 
the growth of the broader industry; and the capabilities and 
strategies of individual companies and, ultimately, the way all 
of that plays into the outlook for their stock prices.
    The Standard & Poor's integrated telecom index, which 
tracks the performance of the major carriers, has fallen in 
each of the past 4 years. It is down 61.5 percent since the 
market's March 2000 peak. The broader market has declined by 
27.2 percent over the same period. So as measured by the stock 
market, the communications market appears to be in relatively 
bad shape.
    Observed through the lens of the consumer, we argue that 
things look rather different. We argue that, for the majority, 
the state of the telecom market looks pretty good. Prices are 
falling. The range of products and services, and the number of 
players offering those products and services is expanding, and 
quality is rising also.
    There are a few data points that seem relevant. First, as 
reported by the FCC in its most recent local competition 
survey, competitive carriers serve 14.7 percent of access lines 
at the retail level, up from 4.3 percent at the end of 1999.
    Second, quality of service reports filed with the FCC 
indicate rising quality of voice service for most all major 
carriers. Third, we estimate that the number of cell phone 
users will exceed the number of U.S. wire line access lines 
sometime during 2005, with cell phone users able to choose 
between six national wireless carriers.
    Fourth, insurgent players such as Vonage have gathered much 
attention as they deploy VoIP. But more importantly perhaps, 
major cable companies have indicated they will deploy VoIP 
phone service to all their markets.
    On the subject of broadband, the level of penetration in 
the U.S. has concerned policymakers. Whilst the 22 percent 
penetration of households here may lag the 80 percent or more 
we see in the market leader today, namely Korea, that deficit 
does not any longer reflect lack of investment by the 
communications industry, in my view. It seems to reflect a 
take-up deficit, not an availability deficit.
    As to regulation, the U.S. regime is certainly complex. I 
do not envy Chairman Powell and his colleagues at the FCC their 
task of fitting today's telecom world into a framework defined 
by the 1996 Act. That said, the Act is clearly having an impact 
as the cross-entry battle between incumbent local and long 
distance wire line carriers heats up.
    Meanwhile, the U.S. bankruptcy laws have had an impact on 
the state of the U.S. industry. We have dubbed ``The 
Frankenstein Effect'' the phenomenon by which several large 
bankrupt long distance carriers such as MCI, Global Crossing 
and others, have or are about to emerge from financial 
restructurings which leave their assets substantially intact 
but their debt burdens greatly reduced. This makes for robust 
competition in the long haul space.
    A crucial measure of the health of an industry is cash-
flow. Combined aggregate free cash-flow before dividends in 
2001 for all of the U.S. telecom service providers covered by 
Merrill Lynch research was negative $4.2 billion. We estimate 
that in 2003 it was positive to the tune of $42 billion, the 
point here being that the industry has refocused attention on 
the most compelling investments that, adapted to the decline 
being experienced in some areas, has responded to investor 
pressure to better manage capital programs and balance sheets, 
and has reduced costs in an effort to maximize profitability 
even in an environment of increased competition.
    Indeed, all of SBC, Bell South and AT&T have acknowledged 
their stronger balance sheets and healthy cash-flows, raising 
their dividends to equity owners by between 16 percent and 27 
percent in 2003.
    My conclusion is that, considered in the round, the state 
of competition in the U.S. telecom marketplace is mostly good. 
There is robust competition in many consumer and business 
markets between traditional providers, promoted by the 1996 
Act, and there is growing intermodal facilities based 
competition from wireless and, increasingly, cable companies.
    Prices are falling, offerings expanding, and quality 
generally is rising. Crucially, the major incumbent carriers 
are dealing with painful transitions as revenues shrink in some 
areas such as wire line voice and especially long distance, 
grow in others, noticeable wireless and broadband, and shift 
between players, yet at the same time are generating adequate 
cash to finance investments in their current infrastructure as 
well as new technologies. Meanwhile, technology change is 
enabling new competitors to enter the marketplace.
    The transition of the telecom industry from a voice centric 
to a data centric model, underway for many years now, is still 
at an early stage. We have no doubt that the winners will be 
the consumers and businesses who use telecom services. For 
telecom investors, the winners in the service provider world 
are much harder to predict.
    Thank you again for inviting me, and I will be happy, in 
due course, to take your questions.
    [The prepared statement of Adam Quinton follows:]

         Prepared Statement of Adam Quinto, Merrill Lynch & Co

    Good afternoon Mr. Chairman and distinguished members of the 
Subcommittee. Thank you for inviting me to appear before you to discuss 
the state of the communications market. I am truly honored to be here.
    As a financial analyst my primary role is to make stock 
recommendations for Merrill Lynch's investor clients. As such my 
perspective on the telecom industry reflects a mix of considerations: 
the broader industry structure and growth outlook, the way factors such 
as technology change and regulation impact the way individual companies 
participate in the growth of the broader industry, the capabilities and 
strategies of individual companies and ultimately the way all that 
plays into the outlook for their stock prices.
    Observed through the lens of the stock market the US telecom 
services industry would appear to be in pretty bad shape. Many 
companies, large and small, have seen collapses in market value since 
the March 2000 peak. In addition there have been many high profile 
bankruptcies, some with alleged fraud. Measured in terms of the S&P 
integrated telecom index stock prices have declined in each of the last 
four years. That makes for a 63.6% decline from January 2000 to January 
2004. Over the same period the broader S&P 500 index fell by only 
24.3%.
    As with the larger market ``bubble'' much time and effort has been 
invested in trying to identify the causes of ``the problem'' of which 
this collapse is deemed to be a manifestation. Also of course many look 
to identify a ``solution''. Was the 1996 Telecom Act flawed? Have there 
been major management failings? What about the role of the FCC? By way 
of example the Columbia University Business School Center for Tele-
Information recently conducted a major research study on ``Remedies for 
Telecom Recovery.'' However, all this deliberation presupposes there is 
a ``problem'' in the first place. Before going any further I think it 
makes sense to review how the market actually looks today:

 As reported by the FCC in its last local competition survey the US 
        has 182.8MM access lines, of which 14.7% are served at a retail 
        level by competitive carriers, up from 4.3% at end 1999. AT&T 
        and MCI in particular are growing their bases of retail access 
        lines served, but so too are smaller competitive carriers 
        operating ``under the radar screen'' of media scrutiny such as 
        Broadview Networks and Paetec. Meanwhile quality of service 
        reports filed with the FCC report rising quality of voice 
        service for most all major carriers--as measured in terms of 
        faults per line, time to repair and so on. For example, based 
        on data reported to the FCC and available through its ARMIS 
        database, total trouble reports per month per 100 residential 
        access lines has trended lower over the past several years from 
        2.79 trouble reports per 100 lines in 1993 to 2.57 in 1996 to 
        2.16 in 2002.
 The US now has 157MM cellular telephone users. Wireless calls account 
        for, we estimate 23% of voice traffic on the US networks with 
        wireless voice minutes rising at 36% per year currently. 
        Indeed, we estimate that the number of cell phone users will 
        exceed the number of US wireline access lines some time during 
        2005. Meanwhile the total number of US access lines fell in 
        2001 for the first time since the Great Depression and 
        continues to fall, despite a strong economy suggesting that 
        long established wireline service is being substituted for by 
        other technologies. For wireless our average price per minute 
        at $0.10 is the lowest of all the developed countries tracked 
        by Merrill Lynch--and still falling at close to 20% per year. 
        This continues to drive new patterns of behavior--indeed an 
        estimated 7% of telephone users only have a cell phone.
 Broadband penetration at end 2003 was 22% of US homes. We estimate 
        total year-end 2003 broadband subscribers of close to 23MM, 
        higher than any other country in the world, with net additions 
        of subscribers of 7MM--the highest absolute level of any 
        country in the world. It has to be said however that 
        penetration is lagging other markets at 22% of homes and 8% on 
        a per head of population basis. Of larger countries Korea and 
        Canada stand out with penetration levels twice or more that of 
        the US. But US penetration still ranks higher than all of the 
        UK, Germany, France and Italy--and some 10x that of China. We 
        project US broadband subscriber growth of roughly another 7MM 
        in 2004 taking penetration to 27% of homes at the end of this 
        year. Broadband subscriber growth in 2001 was just 4.8MM. This 
        acceleration of broadband growth is perhaps not surprising--
        prices have fallen and speeds increased combining to drive 
        improved ``value'' for customers.
 As broadband deployment picks up the new data ``platform'' created by 
        high-speed internet local access and the public internet is 
        being put to use. Insurgent players such as Vonage have 
        gathered much attention as they deploy VoIP, in Vonage's case 
        to just in excess of 100,000 numbers (the term ``line'' becomes 
        meaningless for an IP based offering). More importantly perhaps 
        major cable companies have indicated they will deploy VoIP 
        phone service to all their markets--in Cablevision's case that 
        was achieved end 2003. Meanwhile for the real aficionados there 
        is Skype. Indeed it may well be that VoIP proves to be not just 
        a consequences of, but actually a driver of, broadband take up.
 Major incumbent providers are rising to the challenge. Verizon 
        recently committed to invest $2B over the next two years to 
        accelerate the transformation of its wireline network. As part 
        of that effort they announced that they had selected Nortel as 
        their VoIP equipment provider and, at an investor conference 
        they hosted last week, laid out plans to deploy VoIP over DSL 
        starting next quarter. They cited the benefits to customers of 
        new innovative services and, for themselves, lower costs of 
        network operations. Meanwhile Verizon has also announced it 
        will spend $1B to deploy a high speed wireless service to most 
        major markets by end 2005--offering internet access at speeds 
        8x that of dial up.
 In the enterprise market in November last year SBC announced a VoIP 
        deployment for business as part of this major carriers strategy 
        to compete in the enterprise market in and out of its local 
        service region.
 The industry is offering consumers the opportunity to ``bundle'' 
        services at attractive price points in a way unheard of even 
        just a year ago. For example all of the major ILECs will launch 
        packages of telephony, data and video services (by working with 
        satellite providers Echostar and DirectTV) this year. Better 
        rates are available from cable providers if you take their 
        ``triple play.'' Wireless can be bundled with wireline in some 
        areas with the added benefit of a single bill.
 And finally, as reported in a survey of advertising trends we at 
        Merrill Lynch released in December 2003, the outlook for ad 
        spending by telecom companies remains firm as they seek to 
        promote new services, new packages and new price points.
    Whilst selective these datapoints suggest that when observed 
through the lens of the consumer things look rather different than that 
provided by the stock market. Indeed arguably totally different. As I 
have noted in several of my research reports, investors and for that 
matter company managements looking for some major regulatory shift or 
other ``solution'' to the ``problem'' of telecom miss the fact that, 
for most all of 293MM Americans there is really no major problem. 
Clearly on a case-by-case basis many individuals suffer from service 
availability of quality problems. But I would argue that for the 
majority the state of the telecom market looks pretty good--prices are 
falling, the range of products and services (and the number of players 
offering those products and services) is expanding and quality is 
rising also.
    Note that telephone spending, as a percentage of household 
expenditures, has remained at about 2% for decades. However, think 
about what you get today vs. 20 years ago. Today your telephone service 
includes unlimited local calling, unlimited long distance, a number of 
calling features and a wireless service offering a large bucket of 
minutes and the utility of nationwide coverage.
    On the subject of broadband I know the issue of the level of 
penetration in the US has concerned policy makers. My observations here 
is that whilst the 22% penetration of households may lag the 80%+ we 
see in the ``market leader'' today, namely Korea, that deficit does not 
(any longer) reflect lack of investment by the communications industry. 
The reason I say that is it seems to me that we have a take up deficit, 
not an availability deficit. The three largest wireline providers have 
reported that something at or approaching 80% of their access lines 
were DSL capable at end 2003. And some of the highest levels of DSL 
penetration have been reported by small rural carriers such as Madison 
River. Meanwhile the $80B the cable industry has spent upgrading its 
networks in the past decade gives them close to 100% availability of 
cable high speed data across the 68% of homes served by the cable 
companies (TV homes passed by the cable industry is 95%). That 
suggests, allowing for some mismatch in footprints, perhaps 85% or more 
of US homes have a terrestrial ``pipe'' into their home over which they 
could currently get broadband--if they wanted it and could afford it. 
Indeed combining the two primary terrestrial broadband platforms with 
wireless broadband that will be delivered over conventional cellular 
networks and other means of broadband access (WiFi; so called WISPs--
wireless internet service providers; satellite; powerline) and within 
two years I suspect broadband in some form will be available to 95% of 
homes--that is as many as use conventional phone service today. By then 
uptake will be close to solely a function of affordability and 
desirability.
    It's fair to say that there are aspects of the US scene that do 
look, say we say ``odd''--especially to non-US observers. The US 
bankruptcy laws certainly have an impact on the state of competition in 
the US market that differentiates it from other countries. I have 
dubbed ``The Frankenstein Effect'' the phenomenon by which several 
large bankrupt long distance carriers (such as MCI, Global Crossing, 
Williams Communications, 360 Networks) have or are about to emerge from 
financial restructurings which leave their assets intact but their debt 
burdens greatly reduced. The plus point for the US economy is that 
multi $B investments in new technology networks have not been idled but 
remain in active use. The negative point as, seen by competitors such 
as AT&T, is that over capacity has not been reduced with consequent 
sustained downward pressure on prices. But, as with other areas of US 
telecom where prices are deflating, while AT&T and others are impacted 
the broader economy enjoys the offsetting but more diffuse benefits of 
lower telecommunications costs.
    The US regulatory regime is complex. I for one do not envy Chairman 
Powell and his colleagues at the FCC their task of fitting today's 
telecom world into a framework defined by the 1996 Act. The Act was 
signed into law in February 1996 but as I understand it had been 
several years in the making--so the market structure, technology 
environment in which it was framed is actually close to a decade old. A 
decade is a long time in telecom. One example. I have noted that here 
are 157MM cellular subscribers in the US today--at end 1995 there were 
just 34MM. As a force for so called intermodal competition wireless was 
simply not on the map when the act was being drafted. That said the Act 
is, after some delay and with intervention through the courts all the 
way to the Supreme Court, clearly having an impact as the ``cross 
entry'' battle between incumbent and local carriers heats up.
    A crucial measure of the state of an industry particularly for 
investors is, of course, cash. As investors have been reminded through 
the last several years, companies ultimately generate value for equity 
owners and ensure their viability through the delivery of products and 
services at prices that allow them to cover their day to day expenses, 
invest in assets to support current business and growth opportunities 
as well as meet the needs of the tax collector and providers of debt 
capital. Particularly in telecom ``Free Cash Flow'', the cash left over 
after meeting all these needs and thus available either to distribute 
to equity owners, to pay down debt or perhaps acquire new businesses is 
now a very closely followed metric.
    Despite the genuine anguish that the industry has suffered, 
including of course that of the many workers who have lost their jobs, 
this measure tells an interesting story. I combined the results of the 
all the US telecom service providers, wireline and wireless, covered by 
the Merrill Lynch research team. The result? Aggregate free cash flow 
(before dividends) in 2001 from these companies was negative $4.2B. We 
estimate that in 2003 it was positive to the tune of $42B. The point 
being that the industry has refocused attention on the most compelling 
investments, has adapted to the decline being experienced in some 
areas, has responded to investor pressure to better manage capital 
programs and balance sheets and has reduced costs in an effort to 
maximize profitability even in an environment of increased competition 
and falling prices. Consequently free cash flow has risen dramatically. 
Indeed all of SBC, BellSouth and AT&T acknowledged their stronger 
balance sheets and healthy cash flows and raised their dividends to 
equity owners by between 16% and 27% in 2003. SBC alone pays annual 
dividends now running at $4.2B. I think many people looking at the 
telecom industry might be surprised by these statistics.
    That's not to say that the industry structure is perfect as it is 
by any means. Indeed in any industry undergoing the level of change and 
stress that we see today in telecom new combinations of companies form, 
and more likely than not, there will be consolidation over time in the 
US industry. From the service providers view point consolidation can 
bring more stability to the market structure, which in turn can foster 
investment, so not necessarily being harmful to consumers. I think this 
is one issue that both the anti-trust authorities and telecom 
regulators will have to deal with in the next few years.
    Another challenge, particularly with respect to regulation, is the 
``how do I get there from here'' problem. The nirvana of ubiquitous 
terrestrial and wireless connectivity at broadband speeds offered 
through multiple platforms by multiple providers is one in which 
regulation will likely play a very limited role. However the legacy of 
monopoly, the geographic based and jurisdictional decisions that made 
sense in a monopoly or near monopoly, environment will live on for some 
time. And quite rightly so given the safeguards they provide to 
consumers. But the current framework throws up non-trivial problems 
looking into the future--How should the objective of universal service 
be pursued and funded? Do we consider just basic telephony or broadband 
in our Universal Service objectives--and what about wireless? What 
happens to the access charge regime (especially in rural areas with 
their higher termination rates)? What should the balance between state 
and federal responsibilities be especially in a more data centric 
world? How should VoIP be regulated--is it a phone service or not? 
Whatever it is, how should the balance between economic and social 
policy objectives be struck for VoIP? And would ``too much'' regulatory 
intervention stymie innovation related to VoIP? How do we bring 
together the regulation of cable and telecom as the services each 
offers converge? There are no easy answers to those questions. Whatever 
decisions are made, changes in areas such as the USF and access charge 
regimes will inevitably create winners and losers in the corporate 
world as of course will VoIP.
    My conclusion is that, considered in the round, the state of 
competition in the US telecom market is mostly ``good''. There is 
robust competition in many consumer and business markets between 
traditional providers, there is growing intermodal facilities based 
competition (from wireless and increasingly cable companies). Prices 
are falling, offerings expanding and quality generally is rising. 
Crucially the major incumbent players are dealing with painful 
transitions as revenues shrink in some areas (wireline voice, 
especially long distance), grow in others (noticeably wireless and 
broadband) and shift between players yet at the same time are 
generating adequate cash to finance investments in their current 
infrastructure as well as new technologies. Meanwhile new technology is 
enabling new competitors to enter the market place.
    Finally what changes are to come? My closing thought is that the 
transition of the telecom industry from a voice centric to a data 
centric model, under way for many years now, is still at an early 
stage. Roughly speaking voice accounts for 80% of industry revenues but 
20% of traffic as measured in bits--a form of Pareto rule. As 
technology, and in particular broadband local access break down the 
ring fences around the voice world traffic bits will migrate to the 
cheaper transport path, namely data--and mostly data transported as IP 
packets. As this happens the ties between infrastructure and services 
are broken and, in the jargon, ``voice becomes an application'' running 
over the data network. I suspect that the competitive forces we see 
today will pick up speed--as evidenced late last year when a swathe of 
major carriers announced VoIP services within weeks of each other. In 
this sense I suspect that a more profound reshaping of the industry has 
only just begun. I have no doubt that the consumers and businesses that 
use telecom services will come out clear winners. For telecom investors 
the winners in the service provider world are much harder to predict.

    Mr. Upton. Thank you very much.
    Mr. Zachar.

                   STATEMENT OF NED P. ZACHAR

    Mr. Zachar. Good afternoon. Thank you very much for having 
me, Chairman Upton.
    Mr. Upton. You might need to get that a little closer.
    Mr. Zachar. I am very pleased to be a resource for the 
committee. I am honored to do this. So thank you very much for 
having me.
    My name again is Ned Zachar, and I am the Director of 
Telecom Services Research at Thomas Weisel Partners. I have 
covered the media telecom space for 16 years, all in the 
research side of the business. Our team at Weisel covers 
approximately 30 stocks, both U.S. and international, total 
market cap of $525 billion and a range of companies from a $1 
billion United Online company to some of the largest companies 
in the world, Verizon, AT&T which have multi-billion dollar 
market caps.
    By sector, our coverage includes wireless and wire line, 
cable, DBS, ISPs, Tower Management, which gives us a pretty 
wide perspective on today's topic.
    My comments today are a compilation of several reports we 
have written in the last several months, and they basically 
address the issue of competition head on. So I would like to 
include those as part of the record.
    The increasingly competitive environment for U.S. 
communications companies is a major factor in our investment 
thesis. It directly impacts the sectors that we are encouraging 
investors to be involved in and those sectors which we are 
steering investors away from.
    Generally speaking, we have favored investment in the cable 
and wireless industries and steered people away from the RBOCs 
and the long distance companies, primarily because of the 
market share issues that we are talking about today.
    The communications services business is about $400 billion 
in the U.S., about 3.5 percent of GDP, also growing at about 
3.5 percent on an annual basis, and has been reasonably 
consistent over the last decade or so. While that spending has 
been reasonably consistent, there are several undercurrents 
going on in the industry which, I think, are worth noting.
    First, the effects of the Telecom Act of 1996 have applied 
and continue to apply steady pressure on the established 
incumbent companies such as the RBOCs and the interexchange 
companies like AT&T.
    Second, in our view, technology is accelerating the 
competition between the various subsectors and is a phenomenon 
that is clearly benefiting businesses and consumers.
    For example, because of much better wireless network 
coverage and quality, as many as 5 percent of U.S. households 
have cut the cord and gotten rid of their wire line phones, and 
choosing instead to manage their lives with only a cell phone. 
I think changing U.S. demographics will only accelerate that 
trend.
    At this point in time, we think that the U.S. 
communications marketplace is approaching a significant knee in 
the curve whereby a combination of generally pro-competitive 
policymaking and additional technology advances are set to 
provide U.S. businesses and consumers with new choices in 
service providers as well as new services that do set us apart 
from the rest of the world.
    I want to hit on just a couple of factoids to give you a 
sense of how much market share losses are occurring for the 
incumbents. Consider the following.
    We expect the share of residential lines controlled by the 
ILECs to fall from about 80 percent to around 69 percent over 
the next 5 years. Second, despite the addition of local UNE-P 
lines, we expect the share of telecom dollars controlled by 
AT&T, MCI and Sprint to fall from 11 percent to 8 percent over 
the next 5 years. That is about $4 billion as measured by our 
models.
    Third, we expect the number of wireless users to increase 
from 154 million to almost 200 million over the next 5 years. 
It is hard to tell how many of those are actually going to be 
cutting the cord and going ``wireless only,'' but with 5 
percent roughly today, it is easy to see that you could see a 
number that is two or three times as high in 2008.
    Then last on this point, the number of cable television 
telephone customers, largely using voice over IP, will increase 
to around 3 million to 13 million, again over the next 5 years 
on the tables that contain this data in the back of my 
statement today.
    At this point, let me just shift a little bit toward the 
future. It is a difficult endeavor, but of course, our 
customers want us to do that. We see three major telecom 
tailwinds impacting the communications marketplace today, each 
with their own distinct timeframe. We would define a telecom 
tailwind as a regulatory trend or a technology catalyst which 
would cause changes in behavior either by the service provider 
or the consumer.
    The first telecom tailwind that we are seeing is wireless. 
It is not new, but it remains a very powerful change agent in 
the communications marketplace. It gained serious momentum in 
1996 when the PCS frequencies were auctioned off.
    Since 1996, the number of wireless customers in the U.S. 
has grown at a compound rate of 21 percent, and 13 percent of 
all dialed minutes are now on wireless networks as opposed to 
just 2 percent in 1996.
    The second telecom tailwind is voice over internet 
protocol. Most everybody today has touched on this as a major 
trend. We, of course, agree with that. It is now just coming 
into its own, literally as we speak, and the attractive thing 
about this technology is that, with a relatively modest amount 
of investment, the cable industry, for example, will be able to 
generate very attractive returns on capital, despite modest 
penetration assumptions.
    Third, as far as a telecom tailwind is concerned, is 
wireless broadband, a little bit more of an obtuse concept, but 
we would define it as a mix of established wireless standards, 
including 3G, as well as some emerging technologies, companies 
like Flarion Technologies, Navini Networks, IP Wireless as well 
as WiFi.
    In our view the best hope for affordable ubiquitous 
broadband access is likely to be developed within the wireless 
sector rather than by the established cable telecom duopoly 
that we see today.
    I would like to finish my statement with a handful of 
observations, recapping our viewpoints here. In our view the 
competition in the U.S. telecom marketplace is robust relative 
to the rest of the world, and likely to increase in intensity 
over the next several years because of current legislative and 
agency policies as well as technology.
    Second, the increasingly competitive environment is clearly 
a key factor driving our investment recommendations within our 
research franchise.
    Third, there are several new technologies that are likely 
to intensify that competition moving forward. Last, while I was 
not asked to opine directly, I think there are several items 
that Congress and policymakers, including the FCC, could 
prioritize which would help the industry overall as well as 
consumers, and they include spectrum management issues, 
haphazard local zoning restrictions, E-911 capabilities, UNE-P 
reform, definitional issues such as telecom service versus 
information service definitions, and last, access charge 
reform.
    Thank you very much for listening to my statement.
    [The prepared statement of Ned P. Zachar follows:]

        Prepared Statement of Ned Zachar, Thomas Weisel Partners

                            1. INTRODUCTION

    I am pleased to be a resource for the Committee and am honored to 
have been asked to participate in today's hearing.
    My name is Ned Zachar and I have followed the Media and 
Communications sector--either as a fixed income or equity research 
analyst--for all of my 16-year business career. Our team at Thomas 
Weisel Partners covers approximately 30 US and International companies 
with a publicly traded market capitalization of approximately $525 
billion dollars.
    The size of the companies we cover varies substantially--and 
include $1B market caps such as United Online as well as some of the 
largest companies in the world--including Verizon and AT&T Corp. By 
sector, our coverage includes Wireless and Wireline Telecom, Cable, 
DBS, ISPs, and Tower Management--which gives us a wide perspective on 
today's topic.

        2. TELECOM COMPETITION IS A MAJOR FACTOR IN OUR ANALYSIS

    Today's hearing--of course--addresses the state of competition in 
the telecommunications marketplace. Several reports we have recently 
completed, including our ``2004 Outlook--For Some the Recovery Will 
Continue'' and ``Race for the RGUs''--address this issue head-on. My 
comments today are a summary of those reports and I have included them 
for the record.
    The increasingly competitive environment for US Communications 
companies is a major factor in our overall investment thesis. It 
directly impacts which sectors we are steering investors towards--and 
which sectors we are steering investors away from. Generally speaking, 
we have favored investment in companies that can maintain current 
market share (usually because of a product or technology advantage) 
while stealing successfully from others. In general, the wireless and 
cable industries fit that profile while the RBOCs and especially the 
long distance companies do not.
    Let me elaborate briefly. Based on our Firm's estimates, the US 
Communications Services industry--not including equipment sales--is 
comprised of nearly $400 billion of annual end-user spending. As a % of 
GDP, annual telecom spending is about 3-1/2% of the U.S. economy and 
has been growing on average, roughly in line with the US economy.
    Thus, the pie of spending is quite large but not growing all that 
fast. Average annual spending has been reasonably consistent overall--
though there can be some year-to-year variability within each 
subsector. However, beneath this veneer of consistency, there are 
subtle but powerful undercurrents occurring that we think should be 
noted.
    First, the effects of the 1996 Telecom Act--along with subsequent 
agency and judicial interpretation--have applied and continue to apply 
steady pressure on the established incumbent companies such as the 
RBOCs and the interexchange companies like AT&T Corp. and the 
reconstituted MCI. Our market share statistics in Figure 2c illustrate 
the point.
    Second, in or view, technology is accelerating competition between 
the various subsectors--and is a phenomenon that is clearly benefiting 
businesses and consumers. For example, because of much improved 
wireless network coverage and rapidly falling per minute prices, it has 
been estimated that as many as 5% of US households have dropped 
wireline service altogether--choosing instead to manage their 
relatively mobile lives via a cell phone. Changing US demographics will 
likely accelerate this trend, in our view.
    At this point in time, we believe that the US Communications 
marketplace is approaching a significant ``knee in the curve'' whereby 
the combination of a) generally pro-competitive policymaking and b) 
additional technology advances--are set to provide US businesses and 
consumers with new choices in service providers and/or new services 
that will set us apart from the rest of the world competitively.
    There are several tables at the end of my written testimony that 
illustrate the competitive dynamics I noted above. A few key factoids 
from our tables are relevant to mention:

1) We expect the share of residential lines controlled by the 
        traditional iLECs to fall from 79.2% as of the end of 2003 to 
        68.6% by 2008. Key market share gainers will be the wireless, 
        LD and cable television industries.
2) Despite the addition of local UNEP, we expect the share of telecom 
        dollars controlled by AT&T, MCI, & Sprint (the three major US 
        LD providers) to fall from 10.9% to 7.7% over the same time 
        frame, from $29.7 billion to $25.8 billion.
3) We expect the number of wireless users to increase from 153.8 
        million at the end of 2003 to 196.7 at YE 2008. While we do not 
        estimate how many of those users will be ``wireless only'', 
        with roughly 5 million having already ``cut the cord'' it's 
        reasonable to believe that number would be 2-3x as high in 
        2008.
4) We are estimating that the number of cable television ``telephone'' 
        customers will increase from 3.2 million to 13.0 million 
        between YE 2003 and YE 2008.
5) We estimate that residential high-speed data connections will 
        increase from 23.4 million at YE 2003 to 46.4 million at YE 
        2008. We have also estimated that the cable industry will have 
        about 65.4% market share with the balance held by the iLECs.
6) In pay television, we estimate that the DBS industry will have about 
        30.1% market share by YE 2008, compared to the 23.2% market 
        share they have today. Overall, we expect total pay television 
        subscribers to increase from 93.1 million at YE 2003 to 103.5 
        million at YE 2008, representing 90.5% penetration of U.S. 
        television households.
    Based on our work, the wireless and cable industries--and our data 
supports this--are gaining market share, and thus deserve more 
investment attention--than the RBOCs and the LD companies, which are 
treading water at best.

                    3. FUTURE COMPETITIVE CATALYSTS

    At this point, let me shift the discussion toward predicting the 
future, which is usually a difficult endeavor--but one that our 
customers clearly think is ``part of the job''.
    We see three major ``Telecom Tailwinds'' impacting the competitive 
landscape within the communications marketplace--each with their own 
distinct timeframe. We would define Telecom Tailwinds as technology or 
regulatory trends that are likely to be major catalysts for changes in 
behavior--either by the service providers or their customers.
    1) The first Telecom Tailwind, Wireless, is not a new trend but it 
remains a powerful change agent in the communications marketplace. In 
our view, it really gained momentum in 1996 with the auction of 1900 
MHz PCS spectrum. We expect this tailwind to last for at least several 
more years as US penetration drives toward 70% of the US population. 
The increasing popularity of wireless is being driven primarily by 
ongoing improvement in network quality and changing US demographics. 
Since 1996, the number of wireless customers in the US has grown at a 
compound rate of 20.9% and the number of minutes of use has grown at an 
astounding compound rate of 46.5% annually through 2003. At present, we 
believe the share of minutes on wireless networks is approximately 
13.1% of total reported dial minutes, up from 1.6% in 1996.
    2) The second Telecom Tailwind is Voice over Internet Protocol 
which is really a breakthrough technology that enables voice traffic to 
make use of highly efficient packet-switched networks. VoIP has been 
talked about extensively for several years but is now coming into its 
own--literally as we speak. We are enthusiastic regarding the prospects 
for VoIP technology and its ability to change the economics of telecom. 
It reduces the necessary capital outlay for new competitors and 
enables--for example--the cable industry to generate attractive returns 
on capital with modest penetration assumptions. With regard to the 
incumbents, we do not see VoIP as a significant new tool (other than as 
a mechanism to potentially avoid established regulatory constructs) 
given that their embedded investment in circuit switching remains 
viable and has already been paid for.
    3) And the third Telecom Tailwind we see is Wireless Broadband 
which is a more obtuse concept that we would define as a mix of 
established wireless standards--that is 3g--and emerging technologies 
that will likely eventually enable high speed access--that will allow 
business and consumers to truly ``cut the cord'' for data service. 
Substantive wireless data projects should begin in 2005 and could 
provide added competition for wired data service to homes and 
businesses. While one usually thinks of established European and U.S. 
3G standards for wireless broadband, other new technologies such as 
those developed by Flarion Technologies, Navini Networks and IP 
Wireless represent new opportunities for consumers as well. 
Additionally, the IEEE wireless standard 802.11 (commonly known as 
WiFi) is literally spreading like wildfire despite several inherent 
technology disadvantages--especially the limited range of signal. In 
our view, the best hope for affordable, ubiquitous broadband access 
will likely be developed within the wireless sector--rather than by the 
established cable/telecom high-speed duopoly.

                             4. CONCLUSION

    I finish my statement with a handful of observations recapping the 
current state of competition in telecom.
    a) In our view, competition in the US Telecom marketplace is robust 
relative to the ROW and is likely to increase in intensity in the next 
several years because of current legislative/agency policies and 
technology.
    b) The increasingly competitive environment is clearly a key factor 
in driving our investment recommendations within our research 
franchise.
    c) There are several new technologies that are likely to intensify 
the competitive environment moving forward.
    d) While I was not asked to opine on policy directly, we think 
there are several items that Congress and the FCC could prioritize 
which would help the industry overall AND consumers including: a) 
spectrum management issues, b) haphazard local zoning restrictions c) 
E-911 capability d) UNEP reform e) more refined definitions for telecom 
versus ``information services'' and f) access charge reform.
    On behalf of myself and my Firm, I would like to thank the House 
and specifically the members of the Energy and Commerce Committee for 
listening to my presentation and I would be happy to answer questions 
at the appropriate time.

    Mr. Upton. Well, thank you, all of you. That is for sure. 
At this point we will proceed to members asking questions, and 
we will be observing this 5-minute rule with the clock behind 
us.
    Mr. Balhoff, in your statement you said, and I quote, 
``Accordingly, today we have more competitors offering 
residential local exchange services based on regulatory 
approaches that, however well intentioned, have not spurred 
viable long-term enterprises.''
    I want to focus on the end of that statement, ``have not 
spurred viable long-term enterprises.'' Why do you suppose that 
that is the case?
    Mr. Balhoff. The issue, I believe, is that the current UNE 
and UNE-P regime basically was supposed to be like the 
telecom--the long distance telecom reform that occurred in the 
1980's, and the assumption in that particular period was that, 
if we gave enough discounts, usually through a presubscription 
in the case of long distance--if we gave enough discounts, 
people would get enough customers and would build the assets 
necessary to offer long distance.
    In this case, the profit spread is nowhere near what the 
spread was in long distance in that particular era. So no 
matter how many customers, I think, that the AT&Ts and MCIs of 
the world get, they are not going to be able to justify the 
necessary investment to put loops and robust switching and 
other types of services.
    So my contention is that the current regulatory regime is 
beating its head against the wall on the residential side, 
because we have kept rates low, very successfully, as part of 
public policy for the last 100 years. However, VoIP changes 
that. VoIP effectively offers a much less expensive way to do 
it, so that the technology allows us to create real competition 
that I contend is asset based, and I believe that the 
competition that we had before or we have now on the 
residential side is not really asset based as much as it is 
right now the assets of the LECs.
    Mr. Upton. Well, that goes right to my next question. That 
is: When the cable companies aggressively deploy VoIP, which 
they are about ready to do, why do you think that that calls 
into question the burdensome regulatory regime faced by the 
ILECs?
    Mr. Balhoff. The issue is that right now we have relatively 
unclear rules with respect to the UNEs--that is, how much they 
must discount their investment for not only the legacy 
investment but the new investment. The current rules, the way 
that I read them in the most recent decisions, suggest that the 
carriers are relieved of their obligation to lease their 
network--that is, the incumbent telephone companies--only if 
the fiber optics and the various other electronics actually go 
to the premises.
    Some of the carriers say we need a variety of different 
ways in which to be able to put investment into place in order 
to be able to provide additional alternatives. I am not an 
advocate for the LECs, but what I really see is that the cable 
operators are in the catbird seat currently, because they have 
the ability to offer these types of services that are going to 
be very compelling to consumers, and I think that we need to 
incent and provide clear rules for all of the carriers that are 
out there so that there can be a robust competitive 
marketplace.
    Mr. Upton. Which goes to your statement that you made--It 
goes to the comment that you made in your statement, that we 
indeed have a very uneven playing field as we look to the 
future.
    Mr. Balhoff. Yes. I think technology has really changed it 
effectively, and this is no criticism of anybody from 1996 or 
1999 or whatever. The reality is that technology has now made 
it possible for competitors, small and large, to begin to get 
into these marketplaces. But ultimately, I will contend, it is 
an asset based network, whether it is wireless or cable 
operator or local exchange carrier. It is an asset based 
economy or business that we must really continue to support. 
Otherwise, it is not going to be competitive.
    Mr. Upton. Mr. Quinton, what do you think about that 
statement at the end?
    Mr. Quinton. There is obviously a variety of questions 
there. I think, in terms of the viability of the resale model, 
frankly, from our point of view, the competitive carriers using 
the resale model, many of them, present the financials on a 
somewhat opaque basis. It is actually hard to judge quite what 
the viability is.
    I am aware that there are some smaller private carriers 
operating through a resale model. They have built local 
switching capability. Because of the bottleneck nature of the 
local loop, they have not built local loop, but by using resale 
local loop along with switching of their own provision, they 
are able to generate a business model, create a business model 
which does, on the face of it, work in the sense that it 
produces profit and generates cash-flow.
    So if we go back to the basic question about the viability 
of the model through resale, I think there are some examples 
which prove that it can be a sustainable model.
    Mr. Upton. Mr. Davis is recognized for 8 minutes.
    Mr. Davis. Mr. Chairman, since I just down, can I pass and 
you can come back to me?
    Mr. Upton. Sure. Mr. Stupak, recognized for 5 minutes.
    Mr. Stupak. Thank you, Mr. Chairman. When we talk about 
competition here, Congress and the FCC has repeatedly 
recognized that competition brings lower price and higher 
quality for customers. The FCC's latest statistics, according 
to what I have, show that over 12 percent of the Nation's ZIP 
Codes serving nearly 35 percent of the households have a choice 
of at least 10 providers for voice service.
    Some of these providers use the unbundled network platform, 
UNE-P. Others combine their own facilities with facilities they 
lease from the incumbent carriers. In either case, wouldn't you 
agree that consumers in those areas are benefiting from 
competition? Mr. Balhoff?
    Mr. Balhoff. I think that they are certainly benefiting 
from lower prices. I think that ultimately we are going to have 
to have an entire network that is going to be higher speed band 
width. So the network that we are migrating to is a much 
different network from the one which we have known.
    Mr. Stupak. Well, as we migrate to it, will we be limiting 
competition unless there is some way to broaden that asset 
based economy, as you said?
    Mr. Balhoff. I think that there has to be higher speed band 
width, both from wireless, from the cable operators, and also 
from the local exchange carriers.
    Mr. Stupak. Who has the--I will use the word upper hand 
here, the cable or the local exchange operators?
    Mr. Balhoff. There is no question in my mind that it is the 
cable operator that is capable of much higher speed bandwidths, 
so voice, video and a variety of other things that are 
attractive in the bundle.
    Mr. Stupak. If you were to try to level the playing field 
so we get at this competition, which was, I believe, the goal 
of the 1996 Act, how would you do that? Do you have some 
suggestions on that, if cable has the upper hand now?
    Mr. Balhoff. I don't know that I have suggestions nearly as 
much as I feel that we have got to revisit whether or not the 
playing field is really even to incent the necessary 
investment. My commentaries that I have written about the local 
exchange carriers basically have said it is a rather daunting 
thing for them to actually begin to offer the kind of high 
speed services that it appears that the cable operators are 
going to be able to offer.
    So I think that they are behind the eightball unless they 
begin to invest. The commentaries that I have gotten from a 
number of the CIOs at the telephone companies suggest that the 
difficulty they have is that they do not feel that there is 
enough latitude with respect to the UNE pricing so that 
whatever they invest, unless they go to the premises, is really 
going to have to be shared effectively with the competitors. 
They don't believe that that is a satisfactory proposition.
    I don't have the information to be able to judge that 
fairly. As Mr. Quinton indicated, we don't have all of the data 
that these carriers have.
    Mr. Stupak. Is it fair to say, based upon your testimony, 
that--trying to think how best to phrase it. Is it your 
understanding that Bells, if I can use that word--Bells believe 
that the voice that we are talking about is not subject to 
fees, access fees on their lines?
    Mr. Balhoff. Well, actually, they are paid access rates 
themselves. So they are the beneficiaries of access rates. But 
I think that they want to put in a network that they believe is 
going to be competitive. For the most part, I detect a real 
fear on the part of the Bell companies that they are not going 
to have the necessary assets to compete.
    Mr. Stupak. And on the assets, couldn't the Bells charge 
more on their lines to try to get the monetary necessary to put 
the assets in place?
    Mr. Balhoff. Well, they don't have the freedom to vary the 
kind of charges that they would assess, but I don't think that 
that is really it nearly as much as the fact that they do not 
have the assets to be able to provide the kind of high speed 
services that we are generally seeing being introduced by the 
other operators that are out there.
    Mr. Stupak. Like cable?
    Mr. Balhoff. So the challenge, it seems to me, is that we 
are going to a world that we can fairly clearly see is going to 
be based upon high speed services where their copper based 
network is very well suited to voice but not necessarily to 
high speed services. So they are disadvantaged unless they 
begin to put investment into place. That is my opinion.
    Mr. Stupak. You mentioned quite a bit about the voice in 
your testimony. Voice right now is not subject to an access 
fee. Right?
    Mr. Balhoff. If a long distance carrier or another carrier 
terminates a call in somebody's region, then the local 
telephone company receives in that case about a half a penny 
per minute for that particular service. So they do get paid for 
the use of their network.
    On the voice over IP issue, the thorny problem that the 
regulators are going to have to figure out is whether or not 
access is going to be--whether they have an obligation to pay 
access for these particular services that are terminated or 
originated in somebody's network. Those issues are not yet 
clear, and that is before the FCC at present.
    Mr. Stupak. What is your feeling. Do you think they should 
be subject to fees?
    Mr. Balhoff. I think that people should have to pay for a 
network that they use. That is my opinion.
    Mr. Stupak. No matter where it terminates?
    Mr. Balhoff. The question is whether or not the rates are 
at the same kind of levels, but that is my personal opinion.
    Mr. Stupak. Thank you, Mr. Chairman.
    Mr. Upton. Mr. Stearns.
    Mr. Stearns. Thank you, Mr. Chairman. Mr. Zachar, do you 
see voice, VoIP, emerging as a lower cost technology for 
businesses in terms of moving this packet of communications 
information, voice, media and so forth?
    Mr. Zachar. Somewhat lower cost from an operating 
standpoint, but the primary advantage is that the upfront cost 
to get into the business, the voice over IP equipment that 
basically replicates what a circuit switch can do, costs much, 
much less.
    So it is that much easier to earn a reasonable return on 
the money you are putting out, because if you are talking about 
spending $1 or $2 million as a cable operator in a given 
market, as opposed to $8 or $20 million or even more, you don't 
need a gigantic amount of market share in order to get a fair 
return.
    Mr. Stearns. Earlier, I think Mr. Balhoff mentioned that 
asset backed competitors were necessary to enhance VoIP 
competition. I think in your testimony you say that voice IP is 
not a significant tool for incumbents, given their investment 
in circuit switching. So that is what you are saying here.
    So how would you compare your comment to what he said 
earlier with his asset backed competitors were necessary to 
enhance? I mean, is there a contradiction here?
    Mr. Zachar. I am not sure that there is. What I was trying 
to get across is that I am not sure there is a gigantic benefit 
for the incumbents in using voice over IP other than as a means 
to possibly circumvent regulatory structure. For the cable 
operators who have not invested in circuit switches because it 
has been really expensive--you know, we had a monopoly for, 
basically, the last 100 years or until the last 5 years, for 
reason it is expensive to build these networks, the circuit 
switching that was necessary and in place for the incumbents.
    With the cable operators using voice over IP, they can 
spend not a fraction but much, much less money, get 10 or 15 
percent penetration, and then that is a reasonable economic 
scenario for them, as opposed to having to spend a lot of money 
for circuit switching, which is still a pretty expensive 
endeavor.
    Mr. Stearns. Mr. Balhoff, anything you would like to add?
    Mr. Balhoff. No. I believe that we have really got to parse 
some of the discussion that we have here, because a lot of the 
issues that Ned and various others of us are talking about are 
that there are going to be services that will ride over the 
network, and there is going to be the network that is in place. 
The traditional network is not very robust for the telephone 
companies. It is much more robust because of the investment 
that the cable operators have put in place over the last 7 or 8 
years.
    So we are going to find small companies are going to be 
able to benefit from services that will ride over this network, 
and things that we have not really imagined up to this point in 
time will be beneficiaries. But we have carriers, and we have 
other types of services. I think that this particular network 
makes possible the proliferation of varieties of services.
    Mr. Stearns. I guess this is a question for all the 
witnesses. Do you see, any of you, that there is a major 
regulatory hurdle facing voice IP and, if so, how should this 
be addressed? If you don't think so--I will just start and go 
from my left to my right.
    Mr. Balhoff. I feel picked on. There are a variety of 
things on the voice over IP side. One of them is whether or not 
some sort of access fees are actually going to be assessed on 
them, whether or not----
    Mr. Stearns. You heard my opening statement. We talked 
about universal service, all these things you got to decide.
    Mr. Balhoff. Yes. All of those issues are going to be 
critical issues related to this. One of the problems is that we 
find a way that we have some sort of parity of fees that are 
laid on top of whatever networks, I think, in order that there 
be appropriate competition.
    So I really do believe that the regulators are going to 
have to assess that one. Also, access fees--Right now there are 
inter-carrier groups that are beginning to suggest entirely 
different ways to be paid, because right now there are three 
ways a telephone company is paid.
    One is from access fees, which comes from carrier 
resolutions between them. A second thing, from the customer, 
and the third thing from universal service. So we are probably 
going to see a change in the access regime, and we don't yet 
know what that is going to be at this time.
    Mr. Louthan. I would say there are several issues, the 911 
and Lifeline services as well as law enforcement issues. I 
think those can be largely dealt with, with some technology. I 
think that is something that the industry will probably easily 
come to resolution on.
    Mr. Stearns. I guess you could put software and take care 
of it.
    Mr. Louthan. Correct or some other sort of process that 
would address those issues. I have heard some of those 
described to me by the companies.
    The other issue, as Mike and others have mentioned, is the 
access charges. I think that is something--That is an issue 
that is out there in the industry already, and I think voice 
over IP is probably a catalyst that starts to address the 
issue: How do we look at access charges? What was the original 
intent of them, and as we are looking at the 1996 Act and the 
changes in technology, is this the proper regime going forward? 
That is going to have some big implications for a lot of 
companies. So I think it is one issue that--That is probably 
going to be the more difficult argument for the industry and 
regulators to get around.
    Mr. Quinton. My observation would be that it is important 
to distinguish between what you might call societal regulation 
and economic regulation, and policymakers have to take a view 
on those two things.
    From a societal point of view, there are clearly some 
aspects of the telecom regime which, I think, would be commonly 
accepted as something that should be applied to VoIP just in 
the same way that it applies to conventional telephony. We have 
obviously talked about USF, 911, clear requirements.
    To go beyond that and impose economic regulation as it 
affects pricing and access fees and other things and impose a 
lot more of the burdensome regulation which the common carriers 
currently face is another issue entirely. Again, it is for 
policymakers to decide quite how far to go on that.
    I would make one observation. That is that, despite all the 
press commentary and analysts reports, for that matter, on 
VoIP, we shouldn't forget that currently only .1 percent, 0.1 
percent of telephony subscribers in the U.S. use VoIP. So we 
are talking about something that is still incredibly nascent.
    Mr. Zachar. Adam hit on exactly the right point. I think 
the policymakers have to define what the obligations are of the 
provider, and then from there you can figure out how do you 
create regulatory parity.
    One of the most successful cable operators on the telephone 
side using circuit switching is Cox, and they are about to 
launch in, I believe, North Carolina or Virginia with a voice 
over IP apparatus and infrastructure. They intend to charge 
exactly the same kinds of fees and pay the same kinds of taxes 
that they have been paying on their circuit switch--for their 
circuit switch customers.
    So defining what the obligations are for voice over IP, I 
think, is incredibly important. If they are not required to 
comply with 911 or CALEA, and that is a big issue, and then 
beyond that, how they ought to be paying their fair share of 
the economics, I think, is something that has to be wrestled 
with.
    While a very small number of people are using voice over IP 
today, it feels to me like it is about to explode.
    Mr. Stearns. Thank you, Mr. Chairman.
    Mr. Upton. Thank you. Mr. Davis.
    Mr. Davis. Thanks, Mr. Chairman. My first question is for 
Mr. Quinton. I understand you recently suggested that in the 
case of Verizon, perhaps some of the other Bell or former Bell 
companies, that you expected them to put a lot of emphasis on 
moving faster to deploy VoIP. Could you elaborate on that a 
little bit? Is that an expectation you have for the incumbent 
LECs in general and, if so, why?
    Mr. Quinton. The answer to the question is I do expect them 
to do that. The first observation I would make at a high level 
is that something like an AT-20 rule applies in the telecom 
market, if you look at the difference between traffic volumes 
and revenues.
    By that, I mean roughly 80 percent of the traffic on U.S. 
networks is data traffic, but it only generates about 20 
percent of revenue. The inverse is true when you look at voice. 
Voice is the minority of traffic, but the majority of revenues. 
It seems to me that, inherently, the transmission of voice 
traffic over data networks is going to be an inherently much 
cheaper proposition, and you are going to see a migration of 
that voice revenue to data platforms over time as technology 
allows that to happen.
    I think, from the operator's point of view, as they look at 
that longer term transition, they can see themselves that there 
are significant cost benefits to them moving voice onto a data 
platform, and they, I think, will move to achieve some of those 
benefits which, obviously, have advantages to them in terms of 
reducing costs.
    Also, I think it is not unimportant to add that it is not 
just a cost issue that will drive that transition. Another 
issue is the nature of the service. There are many features 
that you can add to basic voice service that are not currently 
available through the traditional circuit switch architecture.
    Frankly, I think one of the things that will incent the 
incumbents to make this transition is simply that, if they do 
not use the technology, it will be used against them in a 
manner that will be deleterious to them. Obviously, we have 
talked about the cable industry as a mechanism to deliver a 
competing service, possibly quite quickly, using VoIP. I think 
the cable industry using VoIP will be able to take advantage of 
lower costs and deliver a different service with increased 
features. Again, unless the incumbent carriers change 
themselves, they will, I think, have problems over time.
    Mr. Davis. Mr. Balhoff, you take a somewhat different view 
in terms of how you expect the incumbents to take advantage of 
VoIP.
    Mr. Balhoff. I think that there are a couple of things. 
First of all, I agree with Adam that they are going to have to 
offer VoIP services. There is just no question about it. It is 
not just because it is cheaper. Once you begin to use and see 
the services that Vonage and the various other people have 
offered, you find that it is a much richer feature set. So you 
are able to do things that you simply could not do before.
    So the intelligence essentially gets moved from the center 
of the network out to the edge where you can route your calls, 
inhale your voice mail and forward voice mails. It is a very 
attractive platform. However, it has got to be over a network 
that is capable of higher speed bandwidths. So that is the 
issue, again, that the network has to be able to do that. But 
Verizon has announced that it is moving forward, and actually, 
I have had a chance to review their software platform, and it 
is a very attractive platform.
    I have had a chance to use Vonage's. That is also 
attractive. In some ways, I find Verizon's more attractive but, 
actually, the price points for the competitors are going to be 
far below what the telephone companies are going to offer.
    So while Adam is right and Ned is right, that the prices 
are higher right now and it is still nascent, this is about to 
explode rapidly, and the prices very possibly for the good of 
consumers are going to fall out of bed. They are going to drop 
really rapidly, in my opinion.
    Mr. Davis. The decision by the FCC in terms of the 
imposition of an access fee--how critical do you think that 
will be to decisions by the incumbent LECs about deploying the 
VoIP?
    Mr. Balhoff. Well, the problem with access right now is 
that we have had an access regime where in urban markets 
roughly--to terminate a call, it is roughly half a penny. In 
rural markets it is just over two cents. That has been the way 
that we have resolved--I am paying you for the use of your 
network. I, AT&T, am paying you, Verizon, for the use of your 
network.
    If VoIP does not have an obligation to pay that amount of 
money, then that is roughly a third of the cost of the long 
distance calls as we have tended to know them in the past. So 
there will be some sort of cost advantage in that particular 
case.
    So the real issue, the challenge, is to find a different 
way for the incumbent carriers to resolve those access 
payments, and I think there are going to be resolutions where 
we do not have access to be paid by the VoIP providers, and we 
are going to change the regime for the telephone companies, 
because the old regime creates a lack of parity.
    Mr. Davis. I would like to give Mr. Louthan and Mr. Zachar 
the chance to comment on this.
    Mr. Louthan. As far as voice over IP, I agree. It is a 
complete change in how you view telephony. It basically takes 
from a circuit switch role and makes voice telephony a software 
application, and many of the points that Mr. Balhoff is making 
about the services and features, the ease with which the 
company can adjust those and change them, and they are also 
definitely attractive, clearly, for more computer savvy users.
    So it is definitely something that is going to continue to 
be in the forefront of industry. How much we will actually see 
it deployed on a broad scale is going to depend, but I think 
from the incumbent LEC standpoint, they are sort of a win/win 
situation. They are paying access fees and they are having to 
charge their customers the taxes and fees and everything else 
currently. If the voice over IP service is determined not to 
have to pay that, then great. Then they can offer something 
similar to that and match competitors. If not, then maybe the 
competitors have to raise their prices.
    I do tend to agree that prices are higher now, but I think, 
if you look at what the incumbent providers are maybe looking 
to do with non-core services like pushing up video offerings, 
they are definitely going to be offering that for lower 
pricing, trying to get an overall attractive bundle to attract 
customers. The cable companies are doing the same thing, and 
they will probably do the same thing with voice and, if they 
start bundling wireless on a resale basis, they will do the 
same thing with that to try and protect their core customers.
    Mr. Zachar. I am somewhat more dubious on the benefits of 
voice over IP as it pertains to consumers. I think on the 
business side the collection of unified messaging as it 
pertains to voice mail and e-mail--there will be some benefits 
there that would cause the Bells to want to use that as a tool 
in their toolbox, if you will.
    I think on the consumer side, it will take a lot longer for 
consumers to want to warm up to the benefits of voice over IP. 
When I think of voice over IP, I think it is primarily a return 
on investment benefit for the new competitors, something they 
did not have before. They were forced to use circuit switching, 
because that was the only way to play in the public switch 
network, and now that is not the case because of some of the 
real technology advances.
    Mr. Davis. Thank you, Mr. Chairman.
    Mr. Upton. Mr. Barton.
    Mr. Barton. Thank you, Mr. Chairman. Appreciate you doing 
this hearing. I assume you have seen your picture in today's 
paper.
    Mr. Upton. On my Blackberry.
    Mr. Barton. I would comment that, as a subcommittee 
chairman of this subcommittee, you ought to wear a dark suit 
instead of a light suit, but I love the answers down here. I 
totally agreed with your answers. Did you time that for this 
hearing?
    Mr. Upton. They asked the questions. I just responded.
    Mr. Barton. I see. All right. Well, I just have two basic 
questions. My first question, and any of the panel can answer 
it, if you wish to: Where do you see the market penetration of 
the VoIP technology occurring on the timeline? In other words, 
are we going to--Is 20 percent of the market going to be there 
in a year or it is going to be all 100 percent by next year? 
How soon is this thing going to catch on?
    Mr. Louthan. Some of that, you have to look at on a market 
by market basis. If you have cable operators that are pushing 
out voice over IP, they have already got embedded customer 
bases within a specific market, and you will see much higher 
concentrations of it from that standpoint.
    As far as what the Bell companies will actually do, it 
depends on how quickly they actually act in rolling out the 
service. Do they intend to go out of their region with that 
service? Then you have got the smaller players. Vonage has been 
mentioned, getting a tremendously growing market share, but it 
is a nationwide product, and it is coming off a very small 
base.
    So I think you really have to consider that from a market 
by market basis.
    Mr. Barton. That is not an answer. Right now it is a 
curiosity, but if you look at the viability of it, if you 
already have internet access to your home, there is absolutely 
no reason not to go to it tomorrow. So is this going to make 
the cell phone revolution look like the tortoise or do you 
think it is going to take 5 to 10 years?
    Mr. Louthan. It very well could, and the applications are 
there. It is a matter of whether the companies want to actually 
begin rolling that out, and it could take a very significant 
share.
    Mr. Zachar. I will take a stab. I think a third of the 
marketplace in 5 years will be using some type of voice over IP 
technology. I would also make the comment, I think it is 
important what the FCC, this subcommittee, the committee does 
on these issues now. I think that could have a real impact on 
how fast this takes off and how difficult it is from a 
regulatory standpoint for the cable operators to compete or for 
the Bells to compete.
    You know, the decisions you make today will definitely have 
an impact on what happens in the next 4 or 5 years, but I think 
a third of the marketplace will end up on this technology 
within a reasonable amount of time.
    Mr. Barton. Mr. Balhoff?
    Mr. Balhoff. Time Warner a week ago said that in its test 
market in Portland it had achieved a 23 percent penetration of 
its high speed base, which is 9 percent of its video customers 
and roughly, it looks like, 5 percent of the telephony base in 
the entire region within the first year.
    So it is really a very, very rapid move, and I think that 
the speed with which it is adopted is partially going to be a 
function of whether the network is there; because, by and 
large, the telephone companies don't have the network to offer 
it satisfactorily and will not be incented to offer it. The 
cable operators will. So it is a question of whether or not 
they have high speed data.
    Then the other issue is going to be how rapidly the price 
falls. So Vonage is sitting out there at $35 for the most part 
for all you can eat, local and long distance, which compares 
roughly to $65 once you roll in all the fees for Verizon, for 
example, in its service area. But they are also offering a 500 
minute plan for $15. So it is going to be a function of where 
the price goes, and can the price fall rapidly? Absolutely, it 
can.
    Mr. Barton. Well, in my--I live in a little town outside of 
Dallas, and Southwestern Bell is the local provider for 
telephone, and they charge me $50 a month when you include all 
the taxes and everything, and AOL is my internet provider, and 
they charge me, I think, $20. So $70 a month.
    If I understand it correctly, I can go to VoIP through the 
internet right now for $35.
    Mr. Balhoff. Yes, although the quality of service at this 
particular point in time is not necessarily high or uniform. 
But by and large----
    Mr. Barton. That is half.
    Mr. Balhoff. For people who are price sensitive, I think 
that they will be more attracted over to VoIP, but I think 
again the feature set is extremely attractive, once you see it.
    Mr. Barton. Mr. Quinton.
    Mr. Quinton. Before I answer the direct question,I will 
make the observation that you have got to be careful when you 
compare VoIP pricing and telephony pricing. Bear in mind that 
VoIP rides on a broadband connection. So I may be able to get 
service from Vonage or in the near future AT&T and various 
other people priced at attractive levels, but bear in mind that 
you have to have a broadband connection to enable you to get 
that service.
    So depending on quite what your provider is, you may have 
something in the $30 to $45 range entry price for your 
broadband connection before you pay the phone price on top. So 
you have got to be careful about making the comparison.
    Just to answer the direct question, I think one data point 
is relevant to illustrate the potential here. If you look at 
Cox Communications, who have demonstrated that customers are 
prepared to take telephony service from an alternative 
provider--obviously, in that case a cable company--if you look 
at the most developed markets, the markets where they have been 
offering telephony and in this case it is still circuit switch 
telephony for the longest, they have reached penetration of 
something like 50 percent of their basic video subscribers.
    That means that roughly one-third of all of the households 
in their franchise area are taking their telephone service. 
They typically price their service at 10 percent below the 
incumbent phone company. They have achieved, therefore, within 
a 5 or 6-year period a third of the marketplace.
    You could argue that, again niceties of the pricing 
mechanics aside, it is quite possible that VoIP could move at a 
faster rate than that. The reasons it could move at a faster 
rate than that are, firstly, it could well have an 
incrementally lower price point and also, as we have touched 
on, it doesn't just give you telephony at a lower price. It 
gives you better telephony at a lower price in terms of 
additional services.
    Mr. Barton. Well, my time has expired. But I think it is 
going to be faster rather than slower. If that is the case, the 
other issue that we are going to have to address, probably not 
in this Congress but the next Congress, is this universal 
service situation.
    If we have faster penetration in VoIP, it is going to make 
it--We are going to have to do universal service, in my 
opinion, totally different than we are doing it today.
    With that, I yield back to the Chairman.
    Mr. Upton. Thank you. Mr. Engel.
    Mr. Engel. Thank you, Mr. Chairman. I have a couple of 
thoughts and a couple of questions.
    In 1996 we all thought we were passing one of the biggest 
reforms in telecommunications law, and in some ways we did. But 
in other ways, 1996 was already old technology, and the 1996 
Act sections on the telephone industry were, obviously, written 
for an analog world, but today it is, obviously, all bits and 
bytes, ones and zeroes. So, obviously, things have changed.
    So things have changed, and we are now on the verge of 
radically changing how voice telecommunications are handled in 
the United States and around the world, and I am beginning to 
think that we need to change our laws as well. Obviously, what 
the changes look like are important to provide clarity and 
surety to this industry and its investors.
    I want to talk about a level playing field, because I 
really believe that, if we are going to be successful as 
legislators and allow the industry to grow and thrive, we have 
to do our best to ensure that there is a level playing field.
    So if we do have regulations, they need to apply equally to 
all participants, and we have to do little to get in the way of 
these industries developing new and better products. I think 
that things are changing so rapidly that it is just impossible 
for us to think that we can over-regulate and do all kinds of 
things.
    So I would be happy if anybody would care to comment on 
some of the things that I have said. I also would like to ask 
if anyone would care to comment on the fact that the cable 
industry is investing, obviously, billions of dollars to create 
digital broadband networks that it is funneling lots of 
services which are very exciting into consumers' homes, more 
programming, high speed cable modem service, and tradition 
cable telephony.
    Traditional phone companies like Verizon are also investing 
billions to put more fiber into the ground, more coverage for 
high speed internet and more bandwidth. So given this growing 
investment, does this indicate a healthy, competitive market? 
Anyone care to comment on that or any of the other things I 
have said?
    Mr. Quinton. In terms of the competitive marketplace, as I 
said in my testimony, in my summary remarks, if you judge 
competitive market as seen from the consumer standpoint, then 
without it being true in all circumstances, I think it is most 
people's general observation that they have more choice. They 
have more providers offering them service at lower prices.
    I think in the context of that, one thing that perhaps 
during the discussion here we perhaps should have devoted a bit 
more time to is the importance of wireless within that 
equation. We have talked about VoIP, and that is clearly very 
important. But again we shouldn't forget that there is 
something like 150 million cell phone users in the U.S., 
growing at a relatively fast clip, and we shouldn't also omit 
to take into account the fact that wireless is evolving not 
just as a voice platform but as a data platform as well.
    So if you take into account what Verizon announced 
recently, just as one example, the investment of a billion 
dollars in the next 2 years to roll out to major markets 
nationally a high speed data service laid on top of their own 
wireless offering, it is not just what we see happening in the 
terrestrial wire line industry that we should focus on, but 
wireless as well because of the ubiquity of wireless service 
and the way that wireless can move from beyond just a voice 
platform to offering competition in the data world as well.
    Mr. Zachar. I will jump in. I would echo what Adam said. If 
I were going to make suggestions as far as what kinds of things 
policymakers add, the legislature could look at UNE-P reform so 
you see more consistent UNE-P rates across the country and not 
$47 in West Virginia and $10 or $12 in California.
    I would say I would advocate some reasonable parity between 
the voice over IP services that are being provided by the 
Vonages and the cable companies, presuming that the services 
are comparable as to what the telephone companies are having to 
charge their customers.
    Touching on wireless, spectrum management: The way that 
spectrum has been allocated historically is not relevant, I 
think, anymore to meet the needs of the wireless industry. For 
example, there is the rebanding of the 800 megahertz. Most 
people agree that it is a good idea, but it is taking a long 
time to move people around, because the historical incumbents, 
the people that were in place there.
    Also speaking of zoning--or speaking of wireless, the 
difficulty in getting cell sites built so that people have 
improved coverage and we can get to E-911 is, I think, a very 
big issue; because we have talked an awful lot about voice over 
IP and high speed broadband, but there are some really 
interesting things happening on the wireless side, not just 
WiFi, 3G--it is around the corner, is about to occur, and there 
is some new technology; some are calling it 4G, 3G-and a half--
that are, I think, really interesting that could help drive 
prices down and provide better coverage and not have to be 
connected to a cord.
    Mr. Engel. Thank you. I am wondering if I could ask Mr. 
Balhoff just one quick question. How do you see the emergence 
of voice over internet protocol technology affecting 
competition in the communications marketplace in the long term?
    Mr. Balhoff. I think that we are probably going to see a 
stage where anybody who is able to offer high speed services at 
low prices to be benefited. So in the near term, I would expect 
that the cable operators are in very, very good position.
    Over the long term, I think an interesting phenomenon is 
going to occur, and that is that the network providers are 
probably going to become more and more commodity-like, unless 
somebody gets a platform that is so superior to the other.
    I know that the telephone companies' contention is that 
they would like to be able to provide such high speed fiber out 
there that they are able to offer 100 megabit plus symmetric 
services, which they believe would trump what is out there in 
the marketplace with the cable operators. But ultimately, a 
network is a network, and it is probably going to be more and 
more commodity-like, the more the intelligence that is driven 
out into the network.
    So I suspect we are going to see entities like Microsoft 
and software providers and content providers who are probably 
greatly advantaged by the network that is out there. So the 
migration that we are going to go through is going to be away 
from our debate over cable or whoever has the bottleneck with 
the network, over to really who has the most superior services 
to drive across a network where ultimately prices are going to 
be driven lower and lower because of the nature of competition.
    Mr. Engel. Thank you. Thank you, Mr. Chairman.
    Mr. Upton. Thank you. Mr. Shimkus.
    Mr. Shimkus. Thank you, Mr. Chairman. It has been a great 
hearing, and I appreciate the testimony, and we are just back 
for the second session. So now all of us are diving back into a 
lot of these relevant issues, and we kind of forget those 
things. But when we go back home, you know, we are the ones 
that are getting broadband at our home or deciding to use our 
cell phones or not. We are the consumers, too. So we are not 
divorced from this from the public policy debate.
    In my opening statement, I did mention enhanced 911, which 
we are real excited about and the movement going forward in the 
caucus. Really, a consortium of the PSAPs, the E-911 call 
centers and the cellular companies and the ILECs are all 
working together to try to get this stuff rolled out.
    If voice over IP continues, as Chairman Barton has 
projected and most people are saying, would you think that, if 
a universal service and also the acquiring E-911--okay, here is 
the regulatory, I think--acquiring E-911 services over VoIP, 
and also a universal service charge--would that slow the 
deployment of voice over IP?
    Mr. Louthan. No, I don't believe that it would.
    Mr. Shimkus. It would be a small percentage of the overall 
when you are talking about the billions of investments.
    Mr. Balhoff. Most of the reforms that have been proposed 
with respect to universal service are taking it from just what 
is in Section 254 of the Act, which is an assessment on 
interstate traffic and spreading it over a broader base. So the 
net effect, if it is really applied with some sort of parity, 
should be to minimize the effect on the individual connection 
or the revenues, as far as I can tell.
    Mr. Quinton. And my observation would be that, to some 
extent, again societal issues like 911, things that are a 
public good, in a way VoIP offering those actually could 
accelerate the rollout of VoIP, because currently, to the 
extent that somebody is concerned, for example, about cutting 
the cord from a regular phone, moving to a VoIP phone, they may 
well be concerned about 911 capability.
    So to the extent that that is built into VoIP, it could 
actually make the offering more comparable. And if better 
service is there in other respects and prices are lower, then 
other things being equal, it could actually accelerate the 
move.
    I don't think personally that, for example, VoIP carriers 
being asked to pay an appropriate share of the USF burden would 
materially shift the economics. They would still be able to 
provide a cheaper service. So from that point of view, I don't 
think that would be a constraint either.
    Mr. Zachar. Whatever burdens there would be are not enough 
to----
    Mr. Shimkus. That is what I thought. Thank you.
    Let me go to the other great debating issue, and I know 
that we have talked about VoIP, and we have talked about 
cellular. It is interesting that those two that are more 
aggressive are actually moving and grabbing more market share 
are the ones that are the less regulated.
    So when we are looking at terrestrial competition, the 
concern in this debate is how do we get more competition on the 
terrestrial side. The fear would be, well, we are going to 
over-regulate whatever we have now to slow them up. I am just 
talking from public policy debate here. We will hear that in 
the debate, versus easing the regulatory burden on other 
terrestrial providers to allow them to be incentivized to 
provide service.
    I hate to bring up this point, especially with my friend, 
Mr. Pickering here. But you all probably did analyses on the 
Tauzin-Dingell legislation that we tried to put forth. In 
essence, some of us believed that that would have been helpful 
in leveling the playing field.
    Would it have been, based upon your analysis? I mean, I'm 
sure you did that. You have all these big investors that are 
looking for--If you can't tell me, that is fine, but----
    Mr. Balhoff. Candidly, we felt that the--In our shop, we 
felt that the political forces that were aligned against the 
Tauzin-Dingell bill were such that it was not as likely to go 
through at that time. However----
    Mr. Shimkus. So you didn't spend any time doing analysis of 
whether capital would flow?
    Mr. Balhoff. No, Mr. Shimkus, I did not say that.
    Mr. Shimkus. Okay.
    Mr. Balhoff. But the issue is that in the triennial review, 
in effect, a lot of the issues that were raised in the Tauzin-
Dingell actually were permitted to be applied, although 
relatively narrowly, and that is investment to the premise.
    I do think that you raise a critical issue which was part 
of Tauzin-Dingell and was part of the triennial review, but I 
don't believe goes far enough, which is that I think that the 
real issue that we have to look at is how to incent investment. 
Without incenting investment, we cripple the future.
    So my suggestion is not additional regulation, but it is to 
try to find a way that regulation is as low in terms of its 
intervention as possible, so that we find a way only to step in 
when there are things that go awry within the policy arena.
    Mr. Shimkus. Mr. Chairman, I will end, but if anyone else 
on the panel want to finish up on this question, if you would 
allow them to, I would appreciate it. Anyone else want to add 
to that or are you just going to get out while the going is 
good? Man. All right, run for office. You'll get a little more 
guts.
    Mr. Upton. Mr. Pickering.
    Mr. Pickering. Thank you, Mr. Chairman, for having this 
hearing, and I look forward over the next few months to working 
with you as we address the critical issues and the next steps 
that we need to take.
    To my friend, Mr. Shimkus from Illinois, you will be glad 
to know that, in my view, timing is everything; and whereas, 
before I believed it was very important to have the full 
implementation of the Act so that we could have the broadest 
degree of competition in as many forms as possible emerge and 
establish, and I think that is where we are today.
    I think we have had the full implementation of the Act. We 
not only have competition from CLECs, whether it is in 
combination of their own networks or in resale, but we have, 
more importantly, wireless, cable, and we have this exciting 
emergence of voice over internet, and it is now time, in my 
view, to take the next step of major telecom reform, of adding 
into our policy and building onto what we did in 1996.
    I think voice over internet is going to be quickly 
emerging, and it is the technology and the application that 
forces us as policymakers to create a new structure, because as 
you have voice over internet explode, the underpinnings of 
universal service collapse. So it is a driver in trying to make 
sure that you have a predictable, sustainable universal service 
fund in the future.
    As you have that form of competition and multiple platforms 
of competition, then we should be able to begin deregulating 
everything else. We need to make sure that, as voice over 
internet goes forward, that we don't have 50 states trying to 
regulate in different ways voice over internet.
    I think that this is the catalyst that will cause a 
consensus, the stars to align for us to be able to have major 
reform, probably not in this Congress, but what we do in this 
Congress will shape the foundation for what we do in the next 
Congress, and I am looking forward to what that looks like.
    I do think the recommendations that Mr. Zachar mentioned, 
spectrum reform, universal service--Well, I don't know if you 
mentioned universal service reform, but some type of rational 
and sustainable universal service approach.
    What, if any, preemption should we have to protect voice 
over internet as we go forward, and what process do we need to 
address carrier access reform, and the deregulation of local 
incumbents on a going forward basis?
    I have talked more than I asked any questions, but I do 
look forward, Mr. Chairman. I think that the stars are 
aligning, and this is the right time and the right place to 
begin a major reform of telecom. With that, I yield back my 
time.
    Mr. Upton. Thank you, Mr. Pickering. I want to respond to 
that as well, but I want to yield to Mr. Davis for a quick 
question before we finish.
    Mr. Davis. Thank you, Mr. Chairman. I would like to ask Mr. 
Quinton and anyone else who would like to comment on this. You 
made a statement. Part of your statement was that the lack of 
broadband penetration in our country versus Korea and others 
seems to reflect a take-up deficit, more so than availability 
deficit.
    Could you elaborate on that, and particularly what you 
think the cause of that is, and what issues you think the 
Congress should be addressing to deal with the take-up deficit?
    Mr. Quinton. Yes. I think the statistics--although the 
facts are relatively straightforward, if you look at who could 
get broadband if they wanted it, what you will see is that, 
through the period of the last decade or so as cable companies 
have upgraded their networks to two-way capability, most all 
companies with a cable video service could get data service 
from that provider. That is something like 70 million homes.
    If you look at what the major phone companies have 
announced in just the few weeks as they have rounded off the 
year and announced their full year results, you will have 
typically heard from them that something in the range of 75 
percent or more of their access lines are DSL capable. They are 
lines over which DSL could be provided.
    In fact, one of the companies indicated that in the coming 
year they were going to increase that percentage to over 90 
percent. Hence, my observation that, in terms of the 
availability of the service, it is there, and investment has 
been put into cable networks and to incumbent phone company 
networks to enable the service to be provided or to be taken 
up, should the end customer want to do that.
    If you look at other markets around the world where 
penetration is higher, and the two that immediately come to 
mind as most relevant comparisons would be Korea which has the 
highest penetration globally and Canada which has close to the 
highest penetration--they are No. 2 and No. 3 on the ranking 
list and, obviously, you know, is fairly close to home--If you 
look at those two markets, what seems to have driven 
penetration there to high levels in the U.S. is, as I think the 
ITU set out in a report they did on broadband globally last 
September--What has driven penetration there is lower prices 
and prices driven particularly by what I think I described as 
``flourishing competition.'' So again, in the U.S., I think the 
facts speak for themselves. Most people could get broadband if 
they wanted it. There has probably been an issue with pricing 
that has held back demand. So there isn't a supply problem. 
There is a level of demand problem or issue.
    Mr. Zachar. I would only add that the dial-up business in 
the United States was rather robust. AOL did a terrific job of 
spreading the gospel of the internet in the mid to late 1990's. 
It also, I think, has helped maybe encouraged people to--Maybe 
they didn't have to have broadband, whereas the more 
technologically sophisticated culture in Asia adopted this 
technology that much more quickly, as they did in cell phones.
    Mr. Davis. Thank you, Mr. Chairman.
    Mr. Upton. Mr. Shimkus.
    Mr. Shimkus. Thank you, Mr. Chairman. I just want to--Many 
people know that, but today is my staff assistant, Courtney 
Anderson's last hearing here. Many of you worked with her out 
there. She helped pass 911 legislation, kids.us, and the 
enhanced 911 legislation that is still pending on the Senate 
side.
    We are sending her over to the Senate so she can get the E-
911 legislation passed on the Senate side. She is going to be 
working for Senator Brownback. She has been, obviously, as many 
of you know, a great staff assistant, and I am going to miss 
her dearly.
    So this is her last swan song. I wanted to say thank you 
publicly.
    Mr. Upton. There is a lot of things that she can do to get 
that body moving over there. I want to just say, too, Courtney, 
we are going to miss you a lot. You have been great help, 
dot.kids, the whole gamut of things. I don't know what Mr. 
Shimkus is going to do. I don't know if he is going to bother 
to appear without you behind him. You have been a great credit 
to our side. That is for sure.
    I just want to say in conclusion, I appreciate all of your 
comments and the members' attention to this as well today. Mr. 
Pickering put it well, that we have got a long--We have got a 
big challenge ahead of us. I think, Mr. Quinton, you said in 
your statement that 10 years, a decade, is a long time in the 
telecommunications industry.
    Now when this Act was written in the mid-1990's, we didn't 
have Instant Messaging. I don't think a lot of people--Parents 
weren't too concerned about looking over their kids' shoulders, 
looking at the PCs in their house. Didn't have Blackberries. 
Didn't have any of this.
    Yet the system has evolved in a very positive way. We are 
now at that threshold again. You all mentioned Voice over IP. 
That is the way--It's here. It is not coming. It is here. As we 
try to unleash the competitiveness of all the providers, to 
take the regulatory burdens off all the providers and to let 
this industry break out so that consumers as well as industry 
can make our lives, consumers' lives, quite a bit easier, we 
need to address the whole rewrite, I think, of the 1996 Act.
    Now all of us here know it is not going to take a year. It 
is going to take more than that, but we are going to have a 
number of hearings throughout the year to get us ready for that 
challenge. That hopefully will be bipartisan. That should 
really start in an earnest way with the next Congress, but the 
homework has to be done now.
    I appreciate every member's attention to this on both sides 
of the aisle as we begin to roll up our sleeves and address, 
really, that the future is here now.
    I thank you very much for your attention this afternoon, 
and I look forward to the members' participation as we move to 
hearings throughout the year. Thank you. Good luck, Courtney.
    [Whereupon, at 3:02 p.m., the subcommittee was adjourned.]

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